Changes to residential property taxation explained

By Susan Wynne

In recent years the tax system has been used in attempts to reduce investor demand for residential property.  The current Government has now brought into effect promises made by both National and ACT in their election campaigns to reverse tax changes impacting residential property.

Interest deductibility on residential rental properties

One of the changes introduced from the 2021 tax year was the interest limitation rules which targeted residential rental property owners who were claiming tax deductions for interest on the borrowing for their rental properties.

Previous phase out

The previous interest limitation rules limited the proportion of interest costs which could be claimed as a tax deduction as follows:

New phase in

Going forward the interest costs that can be claimed as a tax deduction has changed as highlighted in orange in the table below:

The changes restore the ability to claim interest deductions on residential rental properties to:

• 80% of interest deductions from 1 April 2024 to 31 March 2025
• 100% of interest deductions from 1 April 2025 onwards

These changes apply specifically from 1 April 2024 and 1 April 2025.  Taxpayers with non-standard balance dates, e.g., not 31 March, will need to apportion interest from 1 April in each of the transitional years until interest deductions are allowed in full.

 Under the previous rules certain taxpayers and properties were not subject to the interest limitation rules and these properties and taxpayers will not be impacted by the changes.  For taxpayers who were impacted by the interest limitation rules, the changes will apply regardless of when residential property was purchased, or when funds were borrowed.

Once interest deductions are fully restored, the interest limitation rules will be repealed from 1 April 2025.  Taxpayers who dispose of residential land and are subject to tax on disposal may still be able to claim a deduction for interest that was previously denied under the interest limitation rules at the time of disposal.

It is important to note that the residential ring-fencing rules which limit total deductions for residential rental properties to the extent of rental income remain in place.

Bright-line changes

The bright-line test also targets residential land.  Where residential land is sold and is not taxable under any other tax rules, the bright-line test taxes the gain on sale where residential property is acquired and sold within a specified timeframe.

The current 10-year and 5-year new build bright line tests are being replaced with a new 2-year bright-line test.  This will only apply to disposals of residential land from 1 July 2024 (generally the date a binding contract to sell is formed).

The main home is generally excluded from the bright-line test.  Under the changes the main home exclusion will return to its original more simplified form.  This will generally exclude land from the bright-line test that has been used predominately (more than 50% of the land area) for most of the time it has been owned (more than 50% of the period) as a main home. Periods where a dwelling is being constructed are also ignored for the main home exclusion.

The current rollover rules which provide concession for transfers with certain family trusts and related taxpayers have been extended to apply to most transfers of residential land between associated persons (subject to some limitations).

Conclusion

The question has always been whether the desired policy intent to increase housing supply with the interest limitation and bright-line rules would be effective and if it was worth the complexities introduced to the tax system.  These changes simplify the rules applying to residential properties and provide greater certainty to taxpayers.

If you have any queries about your specific situation, we encourage you to reach out to your regular Deloitte adviser.