This is a special tax update after the government recently made some major changes to the tax treatment of residential rental properties.
Rule change
The change will be that interest will no longer be claimable as an expense. IRD are planning on phasing this in over the next four years.
They have announced this change as a way to allow more kiwis to buy their own homes by making it less beneficial for those who own multiple properties. If you own a rental property and pay a mortgage this will affect you.
Here is a working example of how this could affect you:
Jordan earns $70k per year at his transport job and owns a rental property in Auckland. He has calculated the rental income he receives so that it will cover his mortgage and other expenses on the house.
In the most recent financial year his rental income was $500 per week ($26k for the year), loan interest was $18k and other expenses (rates, insurance, repairs) totalled 8k. This meant profit was nil so he had no tax to pay.
Assuming these figures stay unchanged over the next five years, I will outline approximately how much extra tax Jordan will have to pay each year.
| Year | % of Interest Claimable | Rental Profit | Tax to Pay |
|---|---|---|---|
| 1 | 100% | $0 | $0 |
| 2 | 75% | $4,500 | $1,500 |
| 3 | 50% | $9,000 | $3,000 |
| 4 | 25% | $13,500 | $4,500 |
| 5 | 0% | $18,000 | $6,000 |
What can you do?
You have four options if you own a rental property.
- Do nothing and simply pay more in tax;
- Pay off your mortgage before the changes come into effect;
- Increase weekly rental to cover the increased tax;
- Sell your rental property and diversify your investments.
Under option 1, Jordan would pay a total of $15,000 in tax to IRD over the next five years and $6k every year after that. This is the simplest option for anyone owning a rental profit as they don’t need to do anything apart from paying more in tax.
Option 2 is not a viable option for Jordan because his mortgage is too high to pay off anytime soon. This may be an option for you if you are close to paying off your mortgage. However, you will need to be prepared to pay more in tax once it is fully paid off.
Under option 3, Jordan would need to increase rent by $75 per week every year for the next five years to have enough income to pay expenses and increased tax. The amount of rental increase needed will differ for each person depending on many factors. If you are considering this option, please get in touch with me and I can provide a specific calculation for your situation.
Option 4 may seem like a drastic step, but Jordan could sell his rental property and invest the cash another way to provide income. Other options can be as lucrative, if not more so than owning a rental property. I will outline some of these options in a future newsletter but feel free to get in touch if you would like to know some of these options sooner or have any questions.
Regards -Andrew