Deducting Interest on Rental Property Explained

From 1 April 2024, deducting interest on rental property is being phased back in. This means that more property investors will be able to deduct more interest and further reduce their tax liability. This guide will provide clarity on deducting interest on rental properties in New Zealand, including whether it applies to your situation, how to calculate the deductible interest, and how to include interest in your income tax return.

Beginning 1 April 2024, you can claim 80% of the interest incurred for funds borrowed for residential property, regardless of when it was acquired. Starting from 1 April 2025, full deductibility (100%) will be restored.

What is Deducting Interest on Rental Property?

Interest deduction refers to the ability to claim interest paid on a loan used to purchase, maintain or improve a rental property as an expense on your tax return. This reduces the amount of income that is subject to tax, putting more money back into your pocket and reducing your overall tax liability.

Generally, any property with a dwelling on it (such as a house or apartment) is subject to these rules, including bare land that could be used for residential property. It does not matter whether the property is rented out long-term or for short-stay accommodation some or all of the time, or left vacant.

The interest limitation rules apply to individuals, look-through companies, partnerships, trusts and close companies.

It is important to note that the principle loan repayments themselves are not deductible, only the interest payments on the loan.

How Much Interest Can You Claim?

With residential interest deductions being phased back in, calculating the amount of interest you can deduct for the 2024-2025 financial year onward is relatively straightforward.

From 1 April 2024, you can claim 80% of the interest incurred for funds borrowed for residential property, regardless of when the property was acquired or when the loan was drawn down. Starting from 1 April 2025, full deductibility (100%) will be restored.

Deducting Interest Before 1 April 2024

Before 1 April 2024, deducting interest was being phased out and the rules are a bit more complicated. How much interest you could claim in the 2022-2023 and 2023-2024 financial years dependes on when the property was purchased:

• For properties purchased before 27th March 2021: Interest incurred up to the 31st of March 2024 can be claimed at a reducing rate, from 75% in 2022-2023, reducing to 50% in 2023-2024.
• For properties purchased on or after 27th March 2021: Interest was generally non-deductible unless the property qualified as a ‘new build’.

Exemptions and Exclusions from the Interest Limitation Rules

If the interest limitation rules apply to your property, you can still claim the full amount of interest if you qualify for one of the following exemptions:

• New build: A new build is a self-contained residence that receives a Code Compliance Certificate (CCC) and was added to the land after 27 March 2020. The new build needs to contain its own cooking and bathroom facilities and have its own entrance.
• Land business: Applies for interest relating to land if you hold that land as part of a development, subdivision, land-dealing business, or business of erecting buildings on land.
• Property development: Applies for interest relating to land that you, develop, subdivide, or build on to create a new build.
• Build-to-rent: A medium-to-large scale housing development built to provide long-term rental accommodation.

These property types do not come under the interest limitation rules and you can still claim interest:

• Main home: You generally cannot claim interest deductions for private use, but if you use your main home to earn income (such as from a flatmate, boarder or as short-stay accommodation) you are able to deduct some interest against that income. For example, if 30% of your home is used for rental purposes, you can claim 30% of the interest as a deduction.
• Business premises: Properties used as business premises, like offices and shops. This includes residential properties which are used as business premises (for example, a house converted into a doctor’s surgery).
• Farmland
• Commercial accommodation: Such as hotels, motels, and hostels.

Interest Deductions on the Sale of Property

When you sell or dispose of a residential property you might be able to claim the amount of interest previously disallowed by the interest limitation rules.

If the sale is taxable under the bright-line property rule, you can add the amount of the interest previously disallowed by the interest limitation rules to the cost of the property. The ring-fencing rules for rentals should be applied to any losses.

Including Interest Deductions in Your Income Tax Return

To include interest deductions in your online income tax return, follow these steps:

1. At the ‘Build your return’ step, select Income and expenses from residential property/bright-line income. ‘Interest incurred from residential property’ will then be automatically selected as well.
   
2. Select the secondary form This return will include IR3R Rental Income.
   
3. Enter the Total interest on residential property. This is the total amount of interest accumulated on your loan during the financial year.
   
4. Enter the Interest expense claimed. This is the amount of interest you can claim for the financial year according to the interest limitation rules, exclusions and exceptions.
5. Select a reason for interest expense claimed. The reasons shown apply to 2023-2024 tax year and earlier. These reasons will likely be updated for the 2024-2025 tax year to allow for the new rules.
6. At the ‘Rental income’ step, again enter your total interest, the amount of interest expense claimed and select your reason for claiming the interest.
   

That’s it, you’ve now included interest deductions on your rental property in your online tax return.

For more detailed information and specific scenarios, visit ird.govt.nz and download their IR264 Rental income guide.

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