Earlier this year, the Government announced the removal of tax deductions on loan interest for rental properties. Previously, interest payments were treated as all other business expenses as in that it related to income earning activities or had a nexus to rental income it was claimed as a business expense.
After a very odd explanation on comparing his own home to a rental Grant Robertson declared a loop hole had to be closed and that’s where we come to today!
Now, properties bought from April 2021 onwards will not be able to claim any tax deductions for the interest paid on the mortgages. For all existing rental properties, including holiday home rentals, the tax deductibility is being phased out over four years.
This can result in your property making a loss but you having to pay tax based on the interest not being able to be claimed. This will have a dispraportionate effect on those who hold higher mortgages and smaller holdings (1 or 2 properties).
Changes take effect from 1 October
Until October, the old 100% interest tax deductibility is in place. Then on 1 October this year, rental property tax deductibility reduces to 75%: you can still claim three-quarters of your interest payments as a business expense. The 75% rate remains in place until 31 March, 2023.
For the following financial year (1 April 2023 to 31 March 2024), you’ll be able to claim 50% of your interest payments as a business expense against your rental income. Then it drops to 25% for the next financial year (1 April 2024 to 31 March 2025). From 1 April 2025 onwards, no interest deductibility will be available. You can read more details here.
What should you do?
To assess how much impact this will have on your situation, we can calculate the difference this is likely to make to your overall gains or losses in the years ahead. Our forecasts will be a good guide, but the exact situation will vary depending on several other factors, too. For instance, as interest rate deductibility reduces, you may also find that rents increase to help you meet the higher costs. However, your mortgage interest payments may also go up, if (as seems likely), interest rates increase over that time.
Ideally, you should as always think carefully about your rental properties and whether they will still be fulfilling their role in your financial strategy. You might choose to keep them – switching from interest-only to principal-and-interest repayments could be a way to start reducing your interest costs over time. Or you could sell up and invest the proceeds somewhere else such as commercial properties instead.
Talk to us to get a better understanding of what your position will be when these tax changes come into effect, so you can make smart decisions about your financial future.