New Zealand is under new management and one of the major tax changes Prime Minister Christopher Luxon has made is set to benefit property investors the most.
Until 2021, investors across the ditch had a similar, albeit not as generous, tax advantage as offered by Australia’s much-debated negative gearing.
Landlords were able to fully claim any interest paid on mortgaged investment properties as a deduction against rental income, meaning they could lower their tax bill.
But Jacinda Ardern’s government made a few key changes to how investment properties were taxed and one of them included phasing out the ability for their owners to claim interest as a deduction.
This change did not apply to new builds, with the government saying at the time it wanted to “curb investors’ appetite for existing residential properties”.
The idea was to drive investors away from properties that first-home buyers might have had a chance at buying while keeping them interested in building much-needed new homes.
Three years later and the Ardern-era change has been scrapped.
By this time next year, landlords of both existing or new-build properties will once again be able to claim 100 per cent of their interest expenses as a tax deduction.
So did the Ardern change get a chance to impact the property market and what can Australia learn from the experiment?
What happened to house prices?
The Ardern government had pledged to address New Zealand’s entrenched housing crisis when it came to power in 2017.
But by 2021, the COVID-19 pandemic had brought another crisis and by the time New Zealand emerged from its elimination strategy, house prices had surged to record levels.
New Zealand Reserve Bank data showed that throughout that year, the median house price increased by 27.2 per cent.
The then government brought in a raft of changes, including removing the ability for landlords of existing residential properties to claim interest as a tax deduction.
House prices did begin to fall at the start of 2022, as did the share of the market held by investors, while the first home buyer presence has been increasing.
But several experts warn it is very difficult to attribute that change to any one policy when the dominant force on the market was likely the direction of interest rates.
Landlords lost the ability to fully claim the interest paid on their investment properties on March 27, 2021, but it was just three weeks earlier that the official cash rate started to climb.
Chief economist at Infometrics Brad Olsen said there were some indicators of the impact of removing a landlord’s ability to save on their tax bill by claiming their interest payments.
“You did see a larger pullback on levels of new mortgage commitments going to investors after the announcements were carried through for the likes of interest deductibility,” he said.
“Previously, you were seeing figures around 20-25 per cent of the value of new mortgage commitments were going to investors. That dropped below 20 per cent from about April 2021 onwards and has remained lower since then.
“And at the same time, we’ve seen it pick up for first homebuyers. And that was because with deductibility having been taken away, that didn’t make it quite as financially sustainable for people to be thinking about additional rental properties.”
In terms of just how much New Zealand landlords can save with deductibility, Mr Olsen provides an example. It uses current interest rates.
“An investor of an average priced home assuming the current rental yield, would be having to put in $NZ466 each week cashflow wise to support that house,” he said.
“Even with deductibility — when you can offset the interest payments against your tax bill — those property investors would still be having to sink in $NZ375 a week to support their investments.
“So cashflow wise, those high interest rates are still pretty restrictive no matter if you’ve got deductibility or not.”
Did it impact rents?
As the new New Zealand government announced full interest deductibility was coming back, it was billed as a win for renters.
“Help is on the way for landlords and renters alike. The government’s restoration of interest deductibility will ease pressure on rents and simplify the tax code,” Associate Finance Minister David Seymour said in a statement.
That is of course one of the regular arguments for negative gearing — the theory being that by incentivising investors there will be more supply and lower rents.
Research economist Matthew Maltman who studies the New Zealand housing market said the Ardern-era change was a “big policy change in the rental space”.
“There was kind of a recognition — an acknowledgement — that what the government was trying to do was improve housing affordability in terms of home ownership at the expense, potentially, of rental affordability,” he said.
Because interest deductibility was still being phased out, Mr Maltman said it was hard to know how much impact the policy had on rents.
“Rents have increased in New Zealand over the last couple of years, particularly outside of Auckland,” he said.
“There was a shock to renters, and [the Coalition believes] that going all the way to remove interest deductibility was going to make renting even worse.
“Unfortunately, we don’t have kind of a nice, clean experiment, to kind of test the validity of all these claims.”
Chief economist at Core Logic Kelvin Davidson said that “the supply of rentals might be a bit lower than it otherwise would have been”, but there were other factors at play.
“It’s tempting to say well investors haven’t been buying as many properties, so the stock of rentals isn’t as high as it otherwise would be because of interest deductibility therefore rents have risen,” he said.
“It’s tempting to say that, and it’s part of it, but we’ve also had a net migration boom.
“That’s got nothing to do with interest deductibility and that’s put a lot of pressure on property demand.”
The difference across the ditch
There are some key differences in the way landlords are taxed in New Zealand, both under the Ardern-era policies and the most recent changes.
Landlords have somewhat stricter tax settings year-to-year, but also enjoy no comprehensive capital gains liability.
The key notable differences are:
- Interest deductibility distinguishes between existing properties and new builds
- Ring fencing tax deductibility against rental income only
- No comprehensive capital gains tax
Professor of taxation at Victoria University of Wellington Lisa Marriott explained the concept of “ring fencing”.
“In most places, if you have a loss you can offset that against your other income. So if you have a rental property and salary and wages, you can offset the loss from your rental property against your salary and wages,” she said.
That’s what negative gearing allows Australian property investors to do, and that’s what makes it so controversial.
“We can’t do that here anymore,” Dr Marriott said.
“The losses are contained, or ring fenced, within your property portfolio,” she said.
So if an investor makes a loss on a property, they can only claim the interest deduction against their rental income, not against other income they might earn from a salary.
The new government is not seeking to undo the 2019 change, and while full interest deductibility is coming back, New Zealand investors still won’t be able to claim it against their salaries.
But Kiwi investors do have a significant advantage when it comes to how capital gains are taxed.
There is something called a “bright-line test” that determines whether or not they need to tip some of the gains towards the government once they sell their investment property.
It was originally a National government that brought the test in and then Ardern’s Labour increased its threshold, but at its heart, it was designed to tax the profit made when a property other than the family home was sold.
Until recently the threshold has been 10 years. So if the property is held for 10 years or longer, the investor did not have to pay a tax on the capital gain.
That threshold has now been reduced to two years.
Payday for investors
Dr Marriott said removing the ability for investors to claim interest — which is essentially a business expense — against rental income was a departure from how taxes usually worked.
“It’s not very coherent and we usually say that coherency is something that is desirable in a tax system,” she said.
“Having said that, there are multiple examples where we actually treat certain types of things differently because we want to encourage or to discourage something; look at taxes on tobacco.”
Housing affordability has long been at crisis levels in New Zealand.
The 2018 census found one in four 60 to 64year-olds did not own the home they live in, with that trend to worsen to nearly half by 2053.
The part of the negative gearing story that is difficult to debate is “where the incidence of benefit sits”.
“Where those tax concessions go to the wealthiest in society, I think you can make a really strong argument that it’s not fair,” Dr Marriott said.
So how much will the most recent change return to the pockets of New Zealand investors?
New Zealand’s Council of Trade Unions chief economist Craig Renney puts the figure at nearly $3 billion over four years.
“At the election, the National party claimed that the return of interest deductibility would cost $2.1 billion. Now we discover it’s going to cost nearly $800 million more,” he said.
