Complex Tax Rules for Residential Property Investors
The life of a residential property investor just became a lot more complex after the Government finally released last week its long-awaited draft legislation, relating to its housing tax policy announced on 27 March this year.
Released just three days prior to when it was intended to take effect on 1 October, it is yet to go to Select Committee for further review before it passes into law early next year.
The drat legislation is targeted at residential property investors in an attempt to cool the housing market and make the purchasing of property more affordable for first home buyers. It outlines the new rules that will apply to residential property. These include extending the Bright-Line Test, changes to the Main Home Exemption, the limiting of interest deductions and the introduction of preferential tax treatment for new build housing.
From the date of the announcement on 27 March, the draft legislation divides residential property investors into three separate categories. Each category will be treated differently for income tax purposes. These are as follows:
Investors with existing rental properties
Investors purchasing “pre-loved” properties
Investors purchasing New Build properties
Given the complexity of the legislation, we have summarised for your convenience, the different tax outcomes for each category in the attached link.
In short, what constitutes a “New Build” has been further defined to include when a self-contained residence has been added to land, and it has received its Code of Compliance Certificate on or after 27 March 2020. This includes, prefabricated houses, conversion of existing single dwellings into multiple dwellings, and the conversion of commercial buildings into residential dwellings. A new build retains its new build status for the purposes of the Interest Limitation Rules for a twenty-year period, starting from when its Code of Compliance Certificate has been issued.
Going forward, additional due diligence will be required by investors purchasing properties to determine which category the property qualifies for based on when its Code of Compliance Certificate was issued. Otherwise, they may not be entitled to the interest deductions they thought they were entitled to. The likely result is that tax outcomes will play a larger part in the selection of property purchases going forward. Only time will tell if the new build rules will be enough to entice residential investors to build new homes for renters.
The complexity that the draft legislation brings for residential property investors is significant. It is likely that in the future an investor will have a portfolio made up of properties across all three categories, with each property being taxed differently.
With the onus of proof on the investor to get it right when attending to their tax affairs, gone are the days when a simple rental statement would suffice. The three categories will bring with them higher levels of compliance and cost for property investors.
Property investors will need to carefully keep track of purchase and restructuring dates for Bright-Line purposes for when a property is sold in the future. The tracking of loans and interest to specific properties and Code of Compliance dates will also be required to support the tax position taken for each individual property.
On the upside, it was not all bad news, as the Government did listen to the many requests to allow roll over relief for restructuring purposes for the Interest Limitation rules.
Subject to the interest phase out period, roll over relief will be allowed for interest to continue to be deductible if a change in ownership structure of a residential property occurs for the restructure to a family trust, or, to or from look through companies and partnerships. There is also roll over relief for relationship property settlements and transfer on death.
Given the imposing of a new ten-year Bright-Line Test, roll over relief will be provided for the same restructuring scenarios as the interest deductibility relief for restructuring occurring on or after 1 April 2022, if the amount of the transfer is equal to or less than the original owner’s acquisition cost. Otherwise, a change in ownership structure of a residential property will restart a new Bright-Line Test and the original owner will be taxed on any profit.
The rollover relief proposed could also be problematic for trust resettlements as the transferor to a trust must be a beneficiary who meets the principal settlor definition for the main home exclusion, which requires a natural person.
In summary, what is important to remember that these rules are still only in draft form, which means any aspect of these rules may change. Given this, they cannot be relied upon.
