The Hidden Tax Burden: Mum and Dad Investors Struggle with New Zealand's Property Tax Changes
Introduction:
As the sun sets over the picturesque landscape of New Zealand, the dream of owning a home and a rental property seems attainable for many Kiwis. However, 2021 changes in property tax laws have cast a shadow of uncertainty and financial strain upon Mum and Dad investors with modest means.
As detailed here since 1 October 2021, the following rules apply
Interest cannot be claimed for residential property acquired on or after 27 March 2021 unless an exclusion or exemption applies.
The ability to deduct interest is being phased out between 1 October 2021 and 31 March 2025 for properties acquired before 27 March 2021.
Interest deductions for any new loans drawn down on or after 27 March 2021 will not be allowed from 1 October 2021 onwards.
At present, you are entitled to deduct:
1 April 2023 to 31 March 2024 50%
1 April 2024 to 31 March 2025 25%
On or after 1 April 2025 0%
If you sell your property to a Trust now then you will not be able to claim any interest deductions as “Interest cannot be claimed for residential property acquired on or after 27 March 2021.
In this blog post, we will delve into the real-life challenges faced by one such couple who owns their own home and a rental property, both held in a Trust. We will explore how the gradual reduction and ultimate removal of tax deductibility on mortgage interest are artificially inflating their "on paper" profit, placing an unwarranted burden on their financial stability.
The impact of the 2021 tax changes on Mum and Dad Investors:
Meet Isla and Manaia, a hardworking couple who diligently planned for their future by investing in a rental property. They borrowed to purchase this property, and like many investors, relied on the ability to deduct mortgage interest from their taxable income. However, the 2021 tax changes implemented by the Labour government have upended their financial calculations.
Artificial inflation of profits:
One of the key issues Mum and Dad investors like Isla and Manaia face is the artificial inflation of profits due to the gradual reduction and eventual removal of tax deductibility on mortgage interest. Under the new rules, the interest paid on residential properties acquired on or after 27 March 2021 is being phased out as an expense. This means that even if the rental income falls short of covering the mortgage payments, investors are still expected to pay taxes on the "imaginary" profit.
Isla and Manaia find themselves in this very situation. Despite their rental property generating only enough income to cover the mortgage interest costs, they are now required to pay taxes on the fictional profit that the Labour Government insists they have made. Their modest means and prudent investment decisions are now jeopardised by an unjust tax burden.
The Trust conundrum:
To exacerbate matters, Isla and Manaia hold both their own home and the rental property in a Trust. Labour's tax changes also affect trusts, leaving the couple with limited options to mitigate the impact. If the imaginary profit is retained within the trust, it becomes subject to a staggering 39% tax rate from 1 April 2024. Not only are Mum and Dad investors being taxed on nonexistent profits, but the Government is proposing to tax them even more on these imaginary gains if the trust retains the funds.
The Illusion of Labour's math:
The math behind Labour's tax changes does not add up for Mum and Dad investors. The Government's assertion that investors are making profits when they are actually in a negative cash flow position is fundamentally flawed. By disallowing the deduction of mortgage interest, the Government is disregarding the genuine expenses incurred by investors, such as interest payments. It is imperative to highlight the unjust burden being placed on hardworking individuals and families who are striving to secure their financial future through property investment.
Conclusion:
The plight of Mum and Dad investors like Isla and Manaia reflects the challenges faced by many New Zealanders grappling with recent tax changes. The gradual reduction and eventual removal of tax deductibility on mortgage interest have resulted in an artificially inflated "on paper" profit, burdening investors who may not have actually made any profit at all. Labour's math does not stand up to scrutiny, as it fails to account for the reality of negative gearing and the legitimate expenses associated with property investment.
As a law firm committed to protecting the rights and interests of New Zealanders, Ross Holmes Virtual Lawyers Limited understands the frustrations and concerns of Mum and Dad investors. We are dedicated to providing tailored legal solutions and advocating for fair and reasonable tax policies that support responsible property investment.
