Like many classes of investment, property can go through cycles. Of the two forms of property investment, residential and commercial, residential seems the most prone to volatility. We appear to now be in a cycle where residential is facing headwinds and I explain below how commercial property has some significant advantages over residential in the current market and given Government policy settings.
Residential property has been subjected to significant tax changes in recent years which have been designed to make investment in this sector less appealing, and to tax capital gains. These tax rules are complex and the comments below are intended as a broad overview. Specialist advice should be sought before buying or selling investment property.
In 2015 the then National Government introduced the bright-line test. This is a rule which imposes a de facto capital gains tax on residential property that is sold within a specified timeframe. The initial period was two years but this was extended by the Labour Government to five years from 29 March 2018 and to ten years for properties purchased on or after 27 March 2021.
There are some exclusions that apply for new builds, which continue to have a five-year bright-line period, and for a house which is not subject to tax if it was used as your main home during the bright-line period, the “main home exclusion”. Note that if you did not live in the ‘main home’ for longer than 12 months during the period, tax will apply based on the portion it was not the main home relative to the total ownership period.
In addition to the capital gains tax there are rules that prevent residential property investors from claiming the interest on any debt incurred to purchase their properties. For properties owned before 27 March 2021 interest deductibility is phased out over the next four years so that from 1 April 2025 no interest can be claimed. For loans drawn down after 27 March 2021 there is no interest permitted to be claimed from 1 October 2021, regardless of when the property was purchased. For new build residential properties interest is allowed to be claimed for a period of up to 20 years.
If an investor incurs a loss from their residential rental activity, whether there is interest claimed or not, it is no longer possible to offset that loss against other forms of income. It is irrelevant if the property is a new build. Instead, the loss is ring-fenced to be carried forward, only able to be offset against other residential property income.
If you think this brief summary of the residential property tax rules seems complicated, you are dead right. Even worse, the detail within the legislation is so complex it is an absolute minefield to work through.
It is clear that the current Government has an agenda to reduce the price of residential property, to increase affordability for many. These new rules do not achieve that and the fall in residential property values we are now experiencing is mainly due to an increase in interest rates. These tax changes have only served to unnecessarily complicate residential property ownership.
Other blows against the residential investor are tenant friendly letting rules and healthy homes standards. These rules have resulted in higher costs for landlords and greater constraints on dealing with tenants, no matter how troublesome they may be. On top of all this, I am told by clients who are residential letting agents and property managers, that it has become increasingly difficult to find tenants for vacant property, despite the articles in the media about there being a shortage.
A loss from commercial property may be offset against other income. If ownership is properly structured then that loss may be used to offset income from associated entities, just as for residential in the good old days. Unlike residential property, depreciation may be claimed on commercial building structures and components.
There is no bright-line or other capital gains tax for commercial investors.
The ability to claim full deductions and offset losses provides commercial property investors with a safety valve, meaning that when a loss is incurred they can receive a reduction in their overall tax liability compared to residential property investors.
Commercial leases are generally for much longer terms than residential. This can make planning and budgeting more straightforward. On the other hand, if a commercial property becomes vacant the process of securing a suitable tenant is usually longer compared to a residential property. Also, many commercial leases allow for operational expenses and overheads to be recovered from tenants unlike residential leases.
In summary, the ground has shifted, providing commercial property investment with a much more favourable tax environment, and more predictable cashflow than residential property investment
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Lara Weaver, General Manager
e. lara@dabsconsulting.nz
m. 021 230 5989
145 Kitchener Road, Milford
www.dabsconsulting.nz
