New Zealand's Parliament recently relaxed restrictions on the tax deductibility of interest costs for build-to-rent (BTR) property developments. A concession has been introduced for BTR developments under New Zealand's income tax rules that limit interest deductions for residential property investment. The change was enacted by the Taxation (Annual Rates for 2022-23, Platform Economy, and Remedial Matters) Act 2023 (Tax Amendment Act) on March 31 2023, establishing BTR as a specific and recognised asset class for New Zealand income tax purposes.
What is BTR?
Broadly, BTR assets are large residential developments that comprise several dwellings to be held long-term for rental investment rather than for sale on completion. The developments are professionally managed and usually owned by a single institutional investor. BTR assets offer tenants the security of long-term leases (generally with tenant favourable break rights) and often include additional shared amenities (for example, co-working facilities, gymnasiums, or event venues).
To qualify as BTR land for the purposes of New Zealand's Income Tax Act 2007 (ITA), a BTR development must:
Comprise 20 or more dwellings to be used for residential tenancies;
Offer tenants a fixed-term tenancy of not less than 10 years;
Allow the tenant to personalise the dwelling to a certain extent with the consent of the landlord and in accordance with residential tenancy laws;
Provide that the tenant may terminate on 56 days’ notice;
Not include land that at any time after first meeting the above requirements, fails to meet the above requirements; and
Be registered with the Ministry of Housing and Urban Development, which is responsible for maintaining a register of BTR land.
The BTR sector is significant in many overseas jurisdictions, and many developers and investors have increasingly been looking to invest in this space in New Zealand. Having regard to the current housing crisis across the country, research from Property Council New Zealand indicates that New Zealand could deliver over 25,000 BTR homes in the next decade if the right policy settings are adopted.
There have, however, been a number of domestic policy settings, particularly from a tax perspective, which have affected the feasibility of BTR developments. The Tax Amendment Act addresses one of these key policy issues.
Interest deduction limitation rules
The Tax Amendment Act provides that BTR land is exempted from New Zealand's interest limitation rules for residential properties under the ITA in perpetuity. The interest limitation rules disallow claiming deductions for interest in relation to residential property acquired on or after March 27 2021 (subject to exclusions), and also provide for the phasing out of interest deductions for residential property acquired prior to March 27 2021.
BTR has been added to the list of "exempted residential land" in Schedule 15 of the ITA. This exemption allows investors to deduct (from their taxable income) interest on loans relating to BTR assets, for as long as that interest has a sufficient nexus with the income derived from those assets. The exemption is retrospective from the date the interest limitation rules took effect on October 1 2021.
Further issues for BTR
While the position regarding interest deductibility is a positive step for BTR developments, the Tax Amendment Act does not address all the current legal and economic barriers to BTR in New Zealand.
Residential building owners are effectively not entitled to claim depreciation deductions from their taxable income (as opposed to the owners of non-residential buildings who are able to claim depreciation deductions of either 1.5% or 2% per annum depending on the tax depreciation method adopted). Consequently, the owner of a BTR development will not enjoy the depreciation deductions that the owner of a "non-residential building" is entitled to. Comparable types of accommodation to BTR such as student accommodation and retirement villages are generally treated as non-residential buildings for depreciation purposes.
Residential accommodation is an exempt supply of services for the purposes of the Goods and Services Tax Act 1985. Consequently, residential landlords are generally unable to recover GST input credits for expenses incurred in respect of residential developments. The inability to recover GST during the development stage materially reduces the economic feasibility of a BTR development. It also creates a disadvantage in a situation where an otherwise identical asset is developed for the purposes of selling the individual dwellings.
New Zealand's National Party, currently in opposition, introduced the "Boost Build to Rent Housing Bill" in March 2023. National's proposal seeks to address the depreciation issues by amending the ITA to permit "BTR developments" to claim depreciation deductions for income tax purposes like non-residential buildings. The proposal also seeks to align the treatment of "BTR developments" with student accommodation and retirement villages for the purposes of New Zealand's overseas investment regime, and to streamline the consent process for BTR under that regime.
Neither the Tax Amendment Act nor National's proposal address GST recoverability, although it is expected that the GST issue will be considered from a tax policy perspective soon, following the general election in October 2023.
