By now, the shock of the Government’s move to phase out the deductibility of interest for residential investors will be sinking in.

To refer to this change as the closing of a tax loophole demonstrates naivety or manipulation of the truth. The ability to deduct interest on the financing of an income-earning asset is a foundation principal of our tax system. The move to extend the bright-line to 10 years and create a backdoor CGT on residential land was a bit like the death of an elderly relative – not unexpected but still unwelcome.

National’s stated purpose with the two-year bright-line was to strengthen the intent provisions. Labour was not bold enough to introduce universal CGT but instead extended the bright-line.

The rules create three different property classes. Commercial, existing residential and new build residential. Each class has its own tax rules. Accountants are used to counting dollars, now counting days will be first priority. Three changes to the bright-line dates, and different bright-line dates for new builds and existing stock.

What's The Impact On The Market?

The Government seems to have little idea what the impacts of its initiative will be. This has been implemented against Treasury and IRD advice for the benefit of first home buyers. Most small business finance is secured against taxpayer’s homes and residential investments which has been forgotten.

Investors are doing their sums onwhat the removal of interest deductibility will mean to their cashflows. Many aremaking little surplus and are forced to conclude they won’t have the cashflows to service debt and pay this tax.

Investors who can’t afford the tax must sell. Many are already making the decision to list when buyer demand will be low.

New builds look attractive, but not as attractive as commercial, where there is no bright-line and no loss ring fencing.

On a positive note, the new rules mean interest rates are likely to remain lower for longer. Perhaps it’s time to gain certainty by fixing longer-term rates.

The decision to exempt new builds from the 10-year bright-line and the interest deductibility denial is aimed at incentivising construction. To have made this announcement without providing a definition of a new build though is indefensible. All we have is a vague suggestion that a new build might be one acquired within a year of a code of compliance.

The Government’s promise to never apply bright-line to the family home has been broken. The new announcement contains a “change of use” rule that dilutes the main home exemption. Any home acquired after March 27, rented out for more than one year during ownership, must have a gain on sale within 10 years returned as income in the proportion of the time it wasrented versus the time it was the taxpayer’s home.

I recommend taxpayers continue to record their interest costs despite the inability to deduct them against rent as it seems likely that the new rules may allow an interest claim if a gain on sale is taxable due to a sale within the bright-line period. At present, this is not necessarily the case but it would be unfair to continue to deny a deduction for interest if a gain on sale is taxed.

It’s time to take a breath and weigh up your options. If selling is inevitable, get the process started. Even if triggering tax on a sale within bright-line, the tax is a by-product of exiting with a profit. Reducing debt and that unexpected tax bill may be more important than holding onto the hope of a tax-free gain beyond your brightline period.

Mark and his team specialise in advising on property-related transactions, valuation and restructure services, and tax planning. Withers Tsang & Co Phone 09 376 8860, www.wt.co.nz