With the changes around the interest deductibility of loans for rental properties are they still an attractive form of investment?
In the past the rule has always been; if a loan is made to buy a taxable income stream, such as a share portfolio, rental property, or a profitable business, and the loan was directly related to the earning of that income, the interest on that loan was tax deductible. This is still the case except for the rules around interest deductibility for rental properties which changed in 2020.
For rental properties built before 27 March 2020 the interest on the loan will no longer be deductible after 31 March 2025. This change is being phased in. The interest is 75% deductible for the 2023 financial year, 50% deductible for the 2024 financial year, and will be fully non-deductible in the 2025 financial year.
New builds are exempt from this rule. A new build which received its code of compliance certificate after 27 March 2020 is able to deduct interest for 20 years from the date the certificate was issued. Other exceptions are build-to-rent developments and rental properties leased to Kainga Ora for community housing.
The financial impact is significant for rental investors. For example, the average new investor mortgage debt is $492,342 and investors are facing an extra $6,400 more tax this financial year than they would have had three years ago (Sunday Star Times, April, 16, 2023). By 2025 this will have increased to $12,800. This problem will only compound if mortgage interest rates continue to increase. These increased costs may be difficult to pass onto renters.
The rationale for introducing these rules was to increase the availability of affordable houses for new home buyers and to also create more rental properties via new builds. In our opinion this is a simplistic approach and is unlikely to help those most in need. Up until the changes investors tended to buy older, relatively low priced houses which were affordable for the rental market. Lower income families were able to pay their rent. With the higher costs of ownership landlords are now being confronted with it’s more likely that some of the additional costs will be passed on to renters making homes even more unaffordable. The new home builds will be unlikely to help the lower income families that are struggling the most financially. Some landlords will decide to exit the property market because of their increased costs and falling house prices. Ultimately this will result in still fewer rental properties but will enable first time home buyers to step into the market and buy at reasonable prices. Tough for renters, hopeful for new home buyers.
We have previously discussed rental properties and the housing market in our news article Property Price Expectations.
Property has been popular because the power of leverage; you’re making money on the whole amount invested; your deposit and a bank loan. Your capital gains are based on the full purchase amount. Now that interest costs will no longer be tax deductible on older rentals, rental properties will become less attractive. A few years ago the Government also removed the building depreciation that could be claimed on residential rentals. For a full breakdown of costs that can be claimed refer to IRD rental expense deductions .
You can still make leveraged investments. You can use leverage to invest in an investment portfolio and still have the tax deductibility of the interest on the loan. The other benefits for this form of leverage are; you’ll have easy access to your money as opposed to selling an entire asset. You’ll be invested in more than 10,000 companies across different investment sectors and countries. Diversification is always the key to successful investing.
If you would like to discuss leveraged investing please contact us.
not just the amount you have paid.