In recent weeks, the Government has released their interest deductibility consultation documentation, which comes after the announcement on 23 March 2021 of tax changes affecting residential property investment. The document outlines the proposed design of the interest deductibility limitation and what will be considered a ‘new build’.
As a refresher, the announcements on 23 March 2021 proposed to remove taxpayers’ ability to claim interest deductions on their residential rental properties and to extend the Bright-line test to ten years for residential land. The intention of the changes is to level the playing field between investors and first home buyers.
As previously announced, for residential property acquired on or after 27 March 2021, property owners will be unable to deduct interest beginning 1 October 2021. For properties acquired before 27 March 2021, the ability to deduct interest will be phased out over four years from 1 October 2021 as per the table below.
Taxpayers captured in these rules would include individuals, trusts, partnerships and limited partnerships, close companies (including look-through companies) and any company whose assets are primarily (more than 50%) residential investment property.
The proposals will apply to any property that is being used or is capable of being lived in on a long-term residential basis, so will include many short-term rental properties). It can also include bare land that could have a residential property built on it. However, it is proposed that certain properties may be excluded from this loss of interest deductibility, such as:
Feedback is also being sought on the application of certain types of property, such as where there is a mix of business and residential purposes, serviced managed apartments, student accommodation and short stay accommodation that is not suitable for living in long term.
As mooted in March, ‘new builds’ will be exempt. The basic criteria for a dwelling to be considered a ‘new build’ is it needs to be the addition of a self-contained dwelling with its own kitchen and bathroom and has received code of compliance. Therefore, simply adding a room to an existing dwelling will not count as being a new build. Instead, it could include:
While there was some contemplation of whether ‘new builds’ purchased before 27 March 2021 might be included, the discussion document suggests this will not be the case.
From an interest deductibility perspective, ‘new builds’ will be exempt from the changes. This will apply to anyone who adds a new build to a property or develops a property to add a new build. It will also include anyone who acquires a new build within 12 months of code of compliance being issued.
Up for consultation is how long the exemption will apply for. For instance, whether the exclusion will apply in perpetuity or for a fixed period (such as ten or 20 years). There is also contemplation of whether a subsequent owner could inherit the new build relief. This would likely be for a fixed period but is a useful consideration.
One area where the rules can get complex is around interest allocation and the timing of when interest deductions might be available. This can arise if:
There is also an exemption for property developers. They won’t be automatically exempt however, the development activity will be. The development exemption is intended to apply to activity that results in a dwelling that falls into the classification of a ‘new build’. This will require careful consideration of whether a developer meets this exemption. Further, there are a few scenarios proposed as to whether a full interest deduction should be available. Developers should certainly consider the proposals and provide feedback.
Also outlined is the potential for interest to be deductible upon sale of the property. Whether this will result in a full deductibility, partial deductibility or no ability to deduct is up for consultation. There will be implications for the loss ring-fencing rules and mixed-use asset rules currently in legislation. The government is seeking consultation on how to align the current rules in place and the restrictions on interest deductibility.
The rules also contemplate the avoidance potential of taxpayers who try to structure around the rules by interposing entities to get interest deductibility. It is recommended that taxpayers review their lending structures as they could inadvertently be impacted by these proposals.
The discussion document outlines that changes within an economic group will not reset the Bright-line period. For example, if an individual were to transfer their property to their family trust, the Bright-line period would not reset if the underlying economic interest in the property were still substantially the same. This is a welcome consideration given the concern that the rules become far more prominent with a ten year test.
An additional confirmation is there will be a new Bright-line test for ‘new builds’. It will be a five-year test (like the prior rule), but it will be subject to the same considerations of the ten-year Bright-line test. This is relevant because this imposes the same main home changes that were released in March.
Despite the Governments general position, this document still leaves a lot of questions unanswered until the consultation process has been completed. While the original announcements sounded like they would be easy to implement, many of the proposals highlight some of the inherent complexity that taxpayers will need to work through.
The closing date for affected parties to make submissions is 12 July 2021. If you would like assistance or further information, please contact your adviser or get in touch with the Crowe Tax Advisory team.