What is interest deductibility, and does it still matter now that National has won?

The National government will fully reverse Labour’s interest deductibility tax law by April 2025.

Until then, property investors can claim 80% of their interest expenses from April 1, 2024.

This means property investors will pay less tax and make more money.

It’s a turbulent time, so you might wonder, “How do I stay on top of all of this?”

Here at Opes Partners, our goal is to help you become as informed as possible.

In this article, you’ll learn everything you need to know about interest deductibility. That way you can make the right decision for your portfolio.

QUICK FACTS:

• On April 1, property investors could claim 80% of their interest expenses. This increases to 100% on April 1, 2025
• The tax change means property investors will pay less tax and make more money
• New Builds no longer have a tax advantage over existing properties.

More from Opes Partners:

• Does New Zealand have a capital gains tax? (Article)
• How do I pay less tax on my investment properties? (Article)
  
• Do I have to pay tax under the bright line test in New Zealand? (Article)

Does interest deductibility still matter now National has won?

National has announced property investors can claim 80% of their interest expenses. This was effective from April 1, 2024.

This increases to 100% on April 1, 2025.

This means interest deductibility will still “be a thing” until April 1 next year.

But the change has happened faster than expected.

National and ACT agreed to roll back Labour’s interest deductibility rules.

Here’s how the final policy compares with National’s original proposal:

This means interest deductibility will be fully reinstated a year earlier than expected.

Regardless, it’s a win for property investors.

Who benefits most from the tax changes?

Some investors will see a bigger difference than others.

It depends on what you bought, when you bought it, and who rents it.

Labour’s changes complicated the tax system. They introduced several exemptions. If you had a property that met one of those exemptions you could claim all your interest costs.

• If you use your property for social housing (or it’s exempt, more below) – 100%
• If your property counts as a New Build – 100%
• If you bought your property before March 27 2021 – 50%.
• If you bought your property on or after March 27 2021 – 0%

These are now scrapped.

Here are some examples of who will benefit most from the law change.

#1 – This investor could save $176k

Bob bought a 1970’s house in Auckland last year.

He faced the new, harsh rules straight away. That’s because he bought an existing property after March 2021.

He’s had 0% deductibility. Now he’ll get 80% from April 2024, then 100% from April 2025.

That means Bob will get around $15,000 in tax benefits in the first year since he has an $800k mortgage.

Based on my modelling, he’ll save $176,000 in tax over the next 15 years.

#2 – This investor will be $5,500 better off over the next 12 months

Sally bought a property back in 2020. Like Bob, it’s an $800,000 property in Auckland.

But she hasn’t had to face the full extent of the new tax rules.

That’s because she bought it before March 2021. Last year, Sally had 50% deductibility. That now becomes 80%.

She’ll see a $5,500 tax benefit over the next year.

#3 – This investor has more confidence in the value of their property

Heidi recently bought a New Build. These properties had special benefits under the interest deductibility rules.

They didn’t pay any more tax when the changes came in.

So, what happens when the changes get reversed? Not much changes for Heidi and other New Build investors.

But remember that the “special status” New Builds received only lasted 20 years. Under the new rules, it will continue forever. So, there is a long-term benefit for Heidi.

She won’t have to think, “What will happen to my property’s value once the 20 years are up?”

#4 – Darryl can now rent his house to anyone

Darryl has an old 1960s bungalow.

When the new tax rules came out, he decided to rent his property as social housing. This meant he wouldn’t have to pay as much tax.

So he called up the local Salvation Army and offered it to them.

Under the new rules, he can rent the property to anyone and will not pay any extra tax. So, Darryl has more choice on what he does with his property.

Although he’s happy to keep renting his house to the Salvation Army at the moment; he knows New Zealand needs social housing.

Case Study: This investor will save $110,000 under the new interest deductibility rules

Many property investors will pay less tax under National and ACT’s policy. That will improve cash flow for their properties.

Let’s say Julie owns a rental property with a $500,000 mortgage, which earns $540 a week.

It’s an existing property that would pay more tax under Labour’s laws.

Here’s what her cash flow would look like under the old vs new rules.

Add up the numbers, and National’s new tax law will save her over $110,000 over the next 15 years.

Let’s be clear. She’ll still have negative cashflow under National while interest rates are high.

But over the long term, her cashflow will be much better. That’s because her tax bill will be substantially smaller.

You might read those numbers and think “How is that possible? How is it that an investor would have paid so much more tax under Labour’s policy?”

It all comes down to how the extra tax was calculated.

What were the interest deductibility changes, and what do they do?

Let’s recap what Labour’s interest deductibility changes were.

In 2021, the then-Labour government introduced the new “interest deductibility”.

Property investors pay tax based on their taxable profit. The higher your taxable profit, the more tax you pay.

Profit is based on your income – your expenses.

Before (and very soon to be the case again) mortgage interest costs were an expense.

(Imagine how much more profitable your investment would be if you didn’t have to pay a mortgage).

But when Labour introduced their rules, interest stopped coming into the equation.

So, you were taxed as if you didn’t have a mortgage. But … of course, you still had mortgage costs to pay.

Here is an example of how an investor would make their calculations under Labour’s rules.

So, you got the same amount of rent. You paid the same operating costs. You paid the same amount to the bank, but you paid more money to the IRD.

Is it still worth buying a New Build after the rules change?

New Builds gained significant advantages under Labour’s rules.

It wasn’t just interest deductibility; New Builds also got a shorter bright-line test.

But under National’s rules, it’s an even playing field when it comes to tax.

So many investors ask: “Is it still worth buying a New Build?”

Here at Opes Partners, we help investors buy New Build properties. So there is an incentive to tell you that New Builds are the best.

There are other reasons why you might still consider a New Build.

They need lower deposits and won’t be subject to the Reserve Bank’s Debt-to-Income ratios.

But, that doesn’t mean everyone should buy a New Build.

Some people are better off buying an existing property.

If you want to find out who should buy a New Build and who should buy an existing, read this article.