Landlords Rejoice – The repeal of interest deduction limitations

In 2021, the interest limitation rules were introduced to deny interest deductions for residential investment properties. This policy change significantly affected property owners and investors. In addition, the changes brought about many complications in determining what interest was deductible.

For property acquired on or after 27 March 2021, interest deductions have been denied in full since 1 October 2021.

For property acquired before 27 March 2021 (and provided borrowings were drawn down before this date), an investors interest deductions were gradually phased out:

To address concerns raised by these limitations, the current government has now introduced legislation allowing property investors to claim their interest deductions on a phased approach.

The timeline for these changes is summarised in the table below:

*This period is subject to the existing interest limitation rules but have been included in the above table for clarity.

Key Points

The interest limitation rules are substantially repealed from 1 April 2025. At which point, all taxpayers will be allowed full deductions for their interest expenditure. Until such time, the existing rules will remain in effect while deductibility is reintroduced with the rules continuing to apply as follows:

• The phasing back of interest deductibility will apply to all taxpayers, regardless of when the property was acquired or when the lending was drawn down. It will also cover interest incurred to acquire an ownership interest in, or to become a beneficiary of, an interposed residential property holder (such as a company holding residential land).
  
  For example, an investment property (not a “new build”) purchased on 20 September 2022 which is currently not entitled to interest deductions (as the property was acquired after 27 March 2021), will be permitted to deduct 80% of the interest expenditure from 1 April 2024, and 100% from 1 April 2025 onwards.
   
• Taxpayers with non-standard balance dates will need to calculate the amount of interest denied based on different percentages for different parts of their income year, as the changes adhere to an annual period from 1 April to 31 March.
   
• While most rules will be repealed from April 1, 2025, taxpayers can still claim previously denied interest deductions if they sell residential land that is subject to tax. So, if interest was previously denied due to the limitation rules and proceeds from the property are taxed when sold (e.g., under the bright-line test), that denied interest can be offset against the sale proceeds.
   
• The exemptions for land used as business premises, build-to-rent land, social, emergency, council, or transitional housing, and land held by property developers will remain during the transition period.
   
• The interposed entity and other specific anti-avoidance rules will continue to apply during the phase-out period.

Viewpoint

We support these changes as they will help to ease the burden on property owners and investors by gradually restoring the ability to claim interest deductions on residential investment properties. 

Unfortunately, the loss limitation rules will still apply for residential property investors and no changes are currently signalled in this area.

As any interest expenditure previously denied under the interest limitation rules may be available as a deduction (to reduce tax payable in the event a sale of a property is taxable), we recommend investors continue to track this expenditure as a result.

Bright-line Property Tax Rules Get a Makeover: What You Need to Know

In a major policy shift, the government has reduced the bright-line test period for residential property sales back to two years. Alongside this, several related rules will be simplified, including removing complex apportionment rules for the main home exclusion and expanding rollover relief provisions.

What is the bright-line test?

As a recap, the bright-line test was introduced as a measure to curb property speculation and tax any gains made on the sale of residential land sold within the specified timeframe.

Originally set at two years, the period was extended to five years in 2018 and further extended to 10 years in 2021 to discourage short-term property flipping and speculation.

What are the current rules?

There are currently three different bright-line tests that apply:

• 10-year bright-line test: Applies to residential land acquired on or after 27 March 2021 (excluding new builds) disposed of within 10 years.
• 5-year “new build” bright-line test: Applies to 'new build' residential land acquired on or after 27 March 2021, disposed of within five years.
• 5-year bright-line test: Applies to residential land acquired between 29 March 2018 and 27 March 2021, disposed of within five years.

Residential land includes land with a dwelling on it, land arranged for dwelling construction, or bare land capable of having a dwelling erected. It excludes land used primarily as business premises or farmland.

What’s changing?

The amendment replaces the current tests with a new 2-year bright-line test and takes effect for disposals of residential land where the bright-line end date (generally the date a binding contract to sell is formed) occurs on or after 1 July 2024.

With this change, the bright-line start date will be crucial in determining whether a property sold on or after 1 July 2024 will be subject to the bright-line test.

For standard sales of land, the bright-line start date will continue to be the date the transfer of the land is registered to the person under the Land Transfer Act 2017 and modified in the following situations:
 

Viewpoint

We support this change as it aligns with the original intent of ensuring that land speculators pay their fair share of taxes on property sale gains by simplifying the rules back to their previous form. Simple and well-understood rules encourage compliance and do not impose additional and unnecessary costs in trying to navigate complex rules.

Trust Tax Rate Increases

From the 2024/2025 income year (1 April 2024 for most trusts), the trustee tax rate has been raised from 33% to 39% to align with the top personal tax rate which is 39% for income over $180,000. 

The increase is a result of Inland Revenue’s concerns that trusts may be used as a vehicle to divert income that could be taxed at the lower rate of 33%.

Concession to Mitigate Over-Taxation

To address concerns of over-taxation for certain trusts, some concessions are available. This will mean in certain circumstances, trusts will continue to adopt a rate of 33%. This will apply to:

Trusts with trustee income not exceeding $10,000 after deductible expenses. These trusts qualify as a "de minimis trust" and will continue to apply the 33% tax rate. This de minimis is determined on a per-trust basis per income year. If a person has settled multiple trusts, each trust can separately qualify as a de minimis trust. 

However, settling multiple trusts, or fragmenting an existing trust into multiple trusts, to take advantage of the 33% tax rate for trustee income of a de minimis trust would raise tax avoidance concerns.

Deceased estates are taxed as trusts with all taxable income they derive taxed at the trustee tax rate to the extent it is not beneficiary income. For the first income year of its formation and the subsequent three years, deceased estates will be subject to a tax rate of 33%. After this period, the estate’s tax rate will then increase to 39% but it can still rely on the de minimis trust exemption noted above after this time.

Trusts settled for one or more disabled beneficiaries will be excluded from the 39% trustee tax rate and remain subject to a 33% tax rate on trustee income, provided the trust only has disabled beneficiaries.

Energy consumer trusts will be excluded and remain subject to the 33% trustee tax rate. Legacy superannuation funds will also be excluded and taxed at a 28% tax rate on all their income, the same as widely held superannuation funds.

Corporate Beneficiary Rule

To prevent the use of companies to shelter income from the 39% trustee tax rate, a 'corporate beneficiary rule' has been introduced. This rule ensures that beneficiary income distributed by trustees to certain companies will be subject to the 39% trustee tax rate. This will generally apply to companies owned by the trust or a settlor where five or fewer people or trustees hold more than 50% of the voting interest in the company.

Our thoughts

We welcome the introduction of the two-tiered trust rates as it introduces a fairer tax system given circa 89% of trusts derive assessable income of $180,000 or less. However, the de-minimis threshold in our view is low and we would welcome an increase to a more reasonable threshold as advocated by Chartered Accountants Australia & New Zealand (CA

ANZ). CAANZ identified that 83% of trusts had taxable income below $100,000 and recommended the trustee tax rate of 33% be retained for trusts deriving income of $100,000 or less (see CA ANZ proposal). It is disappointing that the threshold level of $10,000 has been enacted as this results in over-taxation of the majority of trusts. 

Particularly given the changes were enacted to align the trust tax rate with the top personal tax rate which only applies to a small proportion of individual taxpayers.