Investor focus: Interest deductibility

by Carrie Metcalfe on Sep 04, 2024
Article appears under: iRentProperty

 At iRentProperty, we pride ourselves on the depth of experience we bring as property investors. We've had to navigate the complexities of property investment firsthand, including key financial planning elements such as interest deductibility. Our experience has helped us understand how these regulations apply to investment properties, and we're committed to sharing our knowledge with others.

The information in this blog is accurate as of September 2024. We strongly recommend that investors engage a suitably qualified professional for personalized advice and recommendations tailored to their unique circumstances.

Our goal is to empower fellow property investors with insights, but professional guidance is essential for making informed decisions.

What does interest deductibility mean?

The term interest deductibility refers to be ability to deduct mortgage interest expenses from rental property income. By deducting the interest, the taxable income from the property is reduced, and consequently the amount of income tax that is payable can be reduced.  

What are the impacts of interest deductibility for property investors?

For many investors struggling with high interest rates and increasing property rates, the difference of interest deductibility can literally force them to have to sell their investment.

Consider a rental portfolio that generates $50,000, with $18,000 in mortgage interest. If the investor qualifies for interest deductibility, this $18000 could be deducted from the $50,000 income, and the investor has a reduced taxable income of $32,000.

This reduction in taxable income directly affects cash flow and provides investors with increased disposable income available for modernising and improving their property, in turn increasing capital value or leading to rent increases which further increase cash flow.

Multi-property investors usually rely on borrowing to help finance future purchases. Interest deductibility can lead to a more viable property investment and can affect future lending applications.

What are the recent changes to interest deductibility?

Legislative changes under the Labour government meant that investors could only claim 100% interest deductibility in one of two situations:

• For a new build
• If the property is rented to an approved social housing agency

Love or loath these changes, the rules hurt many investors who didn’t have the financial resilience to hold on to their properties without interest deductibility but were unable to initiate tenancies with social housing agencies as they already had tenants.

More recently, the National government as reversed the rules of the previous government and interest deductibility is being phased back in. From April 2025, investors will again be able to deduct 100% of their mortgage interest as an expense against their taxable income.

Case study: Interest deductibility though an approved community housing provider.

A property investor myself, I was keen to test the pros and cons of using community housing as a tactic to support 100% interest deductibility. My intent was to be able to advise my iRentProperty clients with first-hand experience of community housing tenants, coming straight from a city that has a bad rap for community housing.

Rotorua has several service providers that are registered on the community housing register. Registration on the register is essential to be eligible for interest deductibility.

After having met with a few providers and hearing about their values and processes, I eventually settled on a particular agency. Out of respect for our fee-paying clients, we keep the name of this provider confidential.

Once my ‘regular’ tenants gave notice and moved out the of one of my properties, I took the leap and signed up with the provider. The process is exactly the same as with a regular tenancy; the Residential Tenancies Act applies, a tenancy agreement is developed, bond is collected and market rent is collected. The tenancy can be fixed term or periodic and inspections occur as with a regular tenant.  The provider required a negative meth test before sub-letting to their tenant, but meth testing is something I planned to do regardless.

My three-bedroom Western Heights property was quickly tenanted by a single, elderly male who received regular visits from his support team. No partying, no rent arrears, no meth and no issues.

With a rental income of ~$31k and an interest only mortgage requiring payments of $21k p.a, my accountant confirmed that taxable income was reduced to $10k. My accountant asked for copies of the tenancy agreement, bank statements and evidence of the provider being a registered on the community housing register.