How mortgage advisers can approach interest deductions with clients
Relief washed over New Zealand's residential property investor community with the announcement of a fast-tracked rollback on interest deductibility rules.
This policy change offers a significant financial benefit, but a closer look reveals a system that could leave some investors feeling shortchanged.
The seemingly straightforward policy shift comes with some wrinkles, underscoring the importance of seeking professional support during the transition.
But for mortgage advisers, who are well-placed to provide expertise, it could be easier said than done.
“The biggest thing for mortgage advisers to be able to explain the changes clearly to clients,” said Ed McKnight (pictured above left), economist at Opes Partners.
Advisers need to be prepared to be familiar with a variety of investment strategies and remove any bias they have towards any one strategy.
Interest deductibility: What is changing?
Before 2021, residential property investors could deduct their mortgage interest from rental income, minimizing their tax burden. However, a rule change in 2021 began to slowly remove this deduction, significantly increasing their tax bill – even for those making no profit.
This policy, aimed at addressing concerns about housing affordability, backfired according to critics. Many investors, particularly smaller "mum and dad" landlords, struggled with the higher tax burden. Some passed the cost on to tenants by raising rents, while others exited the market entirely, reducing rental availability.
The recent election brought a change in government and tax policy.
The new administration is fast-tracking the return of interest deductibility. Starting in April, investors can deduct 80% of their mortgage interest, rising to 100% by April 2025.
This is a much faster rollback than initially planned, reflecting concerns about the impact on landlords and renters.
Eugene Bartsaikin (pictured above centre), an award-winning mortgage adviser from Twine Financial Advisers, welcomed the change.
Twine Financial Advisers was awarded as one of the Best Mortgage Brokerage Firms in New Zealand. See the full winners here.
“What this does is give younger or newer investors a lifeline, allowing them to hold on longer and see that there's light at the end of the tunnel,” he said.
However, he acknowledged that advisers need to carefully consider the advice they give.
“Advisers need to be prepared to be familiar with a variety of investment strategies and remove any bias they have towards any one strategy,” he said.
McKnight agreed, emphasising the key concern among investors.
“The issue with interest deductibility is that it increased the tax that property investors paid. But instead of increasing the tax rate, they changed how tax was calculated. This made it difficult to explain to property investors,” McKnight said.
“The main takeaway is that it makes property investing more profitable (on the whole) and the rules go back to normal.”
Who gets the most benefit from the tax changes?
While the rules might be reverting to pre-2021, some investors stand to benefit more from the changes than others.
As explained in a recent article by Andrew Nicol (pictured above right), managing partner of Opes and co-host of the Property Academy Podcast with McKnight, it depends on what you bought, when you bought it, and who you rent it out to.
Case study one – This investor could save $176,000
Bob bought a 1970’s house in Auckland last year. He faced the new, harsh rules straight away. That’s because he bought an existing property after March 2021.
Previously on 0% deductibility, he’ll get 80% from April 2024, then 100% from April 2025.
“That means Bob will get around $15,000 in tax benefits in the first year since he has an $800,000 mortgage,” said Nicol. “Based on my modelling, he’ll save $176,000 in tax over the next 15 years.”
Case study two - This investor will be $5,500 better off over the next year
Sally bought a property back in 2020. Like Bob, it’s an $800,000 property in Auckland but she hasn’t had to face the full extent of the new tax rules.
“That’s because she bought it before March 2021. Last year, Sally had 50% deductibility. In a few weeks, that will go to 80%,” Nicol said.
“She’ll see a $5,500 tax benefit over the next year.”
Case study three – This investor has more confidence
Heidi recently bought a new build. These properties had special benefits under the interest deductibility rules and Heidi didn’t pay any more tax when the changes came in.
So, what happens when the changes get reversed? Not much changes for Heidi and other new build investors, according to Nicols.
“But remember that the ‘special status’ new builds got only lasted for 20 years. Under the new rules, it will continue forever. So, there is a long-term benefit for Heidi,” Nicol said. “She won’t have to think, ‘What will happen to my property’s value once the 20 years are up?’”
Case study four – This investor can now rent his house to anyone
Darryl has an old 1960s bungalow. When the new tax rules came out, he decided to rent his property out as social housing. This meant he wouldn’t have to pay as much tax.
So, he called up the local Salvation Army and offered it to them.
“Under the new rules, he can rent the property out to anyone and will not pay any extra tax. So, Darryl has more choices about what he does with his property,” Nicol said. “Though he’s happy to keep renting his house out to the Salvation Army at the moment. He knows New Zealand needs social housing.”
How will the market react come April?
In the short term, McKnight said it would add confidence back to the market.
“Property investors who previously thought ‘nope, the government rules are too tough, I'm not buying’ may start to come back to the market,” he said.
However, McKnight acknowledged that the full impact of the change will take some time to filter through.
“That's because high interest rates are still holding investor demand back. Once rates start to come down, you should see investors coming back in.”
Bartsaikin said the market might see more demand among investors for older properties.
“New builds suit some investors, but those who are hands-on and want to add-value have been struggling to justify renovating and keeping those properties for the rental market,” he said.
Instead Bartsaikin said many have been “forced to sell” to first-home buyers at a profit as these cannot buy properties with too much deferred maintenance due to deposit limitations.
However, for McKnight the most pressing concern for property investors would likely still be “high interest rates, how to handle them, and how long to lock in for”.
“Property investors will want to balance getting an attractive rate today, while still being able to benefit from the potential interest rate falls that may come over the next year,” he said.
Click here to listen to the Property Academy Podcast or article on interest deductibility changes.
How will you help your investor clients understand the changes to interest deductibility? Comment below.
