A wide range of changes aimed at increasing housing supply were announced last week. Among them were significant tax changes, which have left homeowners asking how they might be affected.
A suite of changes aimed at reducing house price inflation and increasing housing supply were announced on March 23, including two changes to the taxation of property.
The five-year bright-line test was extended to 10 years, which means that regardless of intention, that any profit on a property (that is not a main home) sold within ten years of acquisition will be taxed at the personal tax rate.
The other tax change, which is far more significant for property investors, removes interest deductibility. This means investors will no longer be able to offset their mortgage interest expenses against their rental income, when calculating their tax.
For some investors, this will mean rental properties that previously paid for themselves will no longer do so, which ultimately makes property investment a far less attractive proposition.
How might these changes affect homeowners?
The 10-year bright-line test does not apply to your main home. If you have more than one home, your main home is the one where you spend the most time. It also does not apply to inherited property, or to deceased estate property for which you’re an executor or administrator.
So for anyone worried about selling their own home or a home they’ve recently inherited, there’s no need to be concerned about stumping up for a big tax bill upon sale.
There are however, a few exemptions to the rule:
If you use less than 50% of your property as your home (for example 60% of the area of the house is rented as a granny flat) then the main home exclusion does not apply.
If you have a regular pattern of either buying and selling or building and selling your main home then you cannot use the main home exemption.
Same goes if you have used the main home exclusion twice or more over the two-year period immediately before you sold your main home.
If your main home was not used as your main home for any continuous period or periods of more than 12 months during the bright-line period, the main home exclusion will not apply to the period(s). You’ll pay tax on the portion of profit that relates to the period(s). This is the ‘change-of-use’ rule. (For periods of 12 months or less the ‘change-of-use’ rule does not apply.)
What about bach owners?
Baches or second homes are not covered in the main home exemptions and you will be required to pay tax on the profit of the sale if sold within 10 years.
However, new builds are exempted from the 10-year bright-line rule, so if you’re looking to build a bach, or other property, you’ll only be subject to a five-year bright-line rule.
Important things to know
The 10-year bright-line rule may seem like a big deal if you’re either looking at buying a second home, a rental property, a bach or changing the use of your main home for an extended period. But it’s important to remember that any profit you make on the sale of a property within that period will only be taxed at your personal tax rate.
So, if your property increases by $100,000 in value in the period before you sell it, you’ll have to pay personal tax on it in the tax year that you sell it, at the tax rate which applies to your total personal income for the year.
You don’t have to give away all of the profit, and if for some reason your property doesn’t increase in value - then there’s no tax to pay on it.
