Why your property may start to cost you more money soon

Hannah McQueen is a financial adviser, chartered accountant and personal finance author.

OPINION: For most wage and salary earners, the end of the financial year doesn’t mean all that much these days; but for many property investors, that date is likely to be significant.

If you bought an investment property prior to March 27, 2021, that property is likely to start costing you more money from April 1.

That’s because interest costs are being phased out as a tax-deductible expense for investors who own “existing” – rather than “new” – properties.

Your eyes may be glazing over at this point (tax is seldom a thrilling topic, even to me – and I have a Masters in it!). But let me illustrate why this matters.

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Right now, if your property doesn’t meet the definition of “new” in the legislation, from April 1 you go from being able to count 75% of your interest costs as a legitimate tax-deductible expense, to only being able to count 50%.

For property investors who have borrowed money to buy their properties, servicing debt is their biggest expense. In many cases the interest bill (plus the property’s other expenses) total more than the rental income. Usually in that situation, you’d pay no tax – because you haven’t made a profit.

However, the deductibility changes mean you can’t count all those interest costs – which you do have to pay – as an expense for the purposes of tax. So, on paper, the property can start to look like it does make a profit, even if in reality it doesn’t, or at best breaks even.

The impact of that over time will be significant – because next year the scheme phases out further – to 25% – and the year after that, to zero.

So, each year the tax bill will get larger on a profit you’re not making – an entirely different prospect to paying tax out of money you’ve earned! That means the property will become a larger strain on your personal finances.

I know there are seldom many tears shed for property investors, but it pays to remember that most are investing so they can look after themselves in retirement, and not burden anyone else. Most property investors are, for want of a better term, “Mum and Dad investors” and many have mortgages on their own homes. They are not the heartless fat cats they’re often painted as.

But I digress. The upshot is of all this is: the biggest impediment to making money out of property investing tends to be the inability to hold it until the time is right to sell, and this change impacts that ability. Which means if you’re not already, now is the time to start thinking about whether your current property remains the right property for you to hold long-term.

So, if you’re affected by this change, what should you do?

Talk to your accountant to quantify the impact, as they should be able to give you an estimate of what tax exposure you have as the phase out continues.

Then, re-evaluate the property on its merits and drawbacks as of today. What is the property’s yield? What is it costing you today, and what will it cost you when your fixed rates expire? How much are you having to top the property up per week, is there the headroom in your personal finances to absorb that? What impact will that have on your home mortgage repayment timeframe? What repairs and maintenance are likely to be required soon? Is any work required to make it compliant with Healthy Homes regulations and if so, what will it cost? What prospects does it have for future capital gain – has it had its boom, or is it still to come? Is there anything about it that could diminish or enhance its future value, for example its zoning, or other development in the area having an impact on its appeal?

Then, consider the impact of selling it. Would you make a capital gain? Would selling trigger the bright-line capital gains tax? If so, what previous losses could be used to offset that? If you were to sell it, how much capital would be released, and what else could that be used for? Would you still have the capacity to borrow for another property at today’s bank test rates?

Both of these tests need to be done as dispassionately as possible, which can be tricky. Maybe it was your first home, and your kids were born there; maybe you imagined your adult kids setting up home there; or perhaps you’re proud of your DIY work.

But I find that any sentimentality quickly dissipates once you quantify the impact of continuing to own a poor performing property – so focus on the numbers and use the end of the financial year as a chance to reassess your property investment strategy.