The government announced a raft of policies on 23 March 2021 (yesterday) aimed at the housing market. Out of the announcement, there were some tax changes that will significantly impact on property owners and investors. The changes are:

1. The current bright-line period will be extended to 10 years for properties acquired on or after 27 March 2021, except for new builds.
2. The existing “main home” exemption will also be amended to reflect the split between personal and rental use.
3. Interest costs will no longer be deductible for income tax purposes for properties acquired after 27 March 2021. An exemption for new builds will also be introduced by the government after a consultation period.
4. For existing properties, interest deductions will be phased out over four years.

Bright-line Test Proposed Change

The bright-line test means if you sell a residential property within a set period after acquiring it you will be required to pay income tax on any profit made through the property increasing in value. For properties acquired on or after 27 March 2021, the bright-line period will be 10 years (increased from 5 years).

However, for the purchase of “new builds”, the bright-line period will remain at 5 years. The definition of “new build” is yet to be worked out by the government, but it is intended to include properties that are acquired within a year of receiving their code compliance certificate.

For tax purposes, a property is generally acquired on the date a binding sale and purchase agreement is signed, as opposed to the settlement date.

Change To The “Main Home” Exemption

Currently the rules provides an exemption to the bright-line test if it was used as your main home. In order to qualify, you had to have lived in the property for more than 50% of the time of total ownership, and more than 50% of the total floor area of the house was used as your main home.

The current rules applied on an “all or nothing” basis. Meaning, if you qualify for the main home exemption, then none of the gain on sale will be taxable.

This will now change. For properties acquired on or after 27 March 2021, the gain on sale that relates to the period of ownership that the property was not used as a main home will now be taxable. For example, if you rented your house out for 1 year, and then lived in it for 2 years and then sold the property, 1/3 (being 1 year of rental out of 3 years of ownership) of the gain on the sale will be taxable. This change will include new builds.

 Interest Deductions on Residential Property

Currently, the interest that you pay on your mortgage is able to be offset against the rental income, so as to reduce the tax liable to be paid on the rental property. However, for properties acquired on or after 27 March 2021, interest costs incurred after 1 October 2021 will no longer be deductible against rental income.

Existing Properties

For properties acquired before 27 March 2021, interest deductions will be phased out over four years according to the table below: 

The government intendeds to provide an exemption for new builds to this new rule after a consultant period. It will also decide after a consultation period whether all people who are eventually taxed on the sale of property should be able to deduct their interest expense at the time of sale. More details are to come on that.

You will also need to beware that interest costs on any new borrowings on or after 27 March 2021 will not be deductible for income tax, even if the property itself was acquired before 27 March. This is important to know as any “top up” mortgages or possibly refinance via a new loan will mean the interest costs will no longer be deductible.

Tip for Advanced Players

One thing that not many people are aware of is that where you are a nominee to a Sale and Purchase Agreement, the date of acquisition for the nominee is not the Sale and Purchase Agreement date, but rather the date that the Deed of Nomination was signed. So please get your Deed of Nomination finalised before 27 March 2021 if you want to avoid the 10 year bright-line period.

Final Thoughts

These are some very significant changes to the tax rules around properties.  In particular, the biggest cost for a rental property is the mortgage, so the change to interest deductibility rules means that after paying the bank, there might be a significant cash shortfall to pay income tax on the rental properties. This will strain the cash flow for many mom and dad investors.

It’s good that the government is intending to exclude new builds from these changes, but the details of that have not come out yet, so watch this space. We will keep you posted.