Tax Impact of Converting Short Term to Long Term
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Articles by Matthew Gilligan
With New Zealand’s borders being closed, and likely to be closed for some time, a number of clients who have rented properties on a short-term basis (e.g. via Airbnb) are converting those properties to long-term residential tenancies. This raises the question – what are the tax implications?
Income tax
Whether a property is rented out on a short or long-term basis, income received is taxable. However, there are points of difference when it comes to claiming expenses and losses.
Where a property is rented out on a short-term basis it can be classified as a “mixed-use asset”.
• One example of a mixed-use asset is your classic holiday home that is used privately on occasion, rented out on occasion and frequently vacant.
• If a property is classified as a mixed-use asset, not all of the expenses are deductible. There are specific rules that scale back the expenses able to be claimed.
• Further, there are “loss quarantining” rules that can prevent any tax losses from being offset against other forms of income. These rules apply to mixed use assets only if the rent falls below 2% of the value of the property.
• A property that is rented out on a short-term stay basis, but not used privately, will not be classified as a mixed-use asset. Expenditure incurred in relation to these properties is fully deductible, though it is possible the residential loss ring-fencing rules may still apply – this is a murky issue.
Once a property is rented out long term to residential tenants, the residential loss ring-fencing rules will apply. These rules prevent you from offsetting tax losses against other forms of income. They apply to all residential properties, and unlike the loss quarantining rules for mixed use assets, apply irrespective of the quantum of income.
GST
If you are registered for GST there can be significant implications of changing a property from short-term stay to long-term residential rental use.
• GST can apply to the provision of short-term stay accommodation either voluntarily, or compulsorily if your turnover is more than $60,000 per annum.
• If a property is in the GST net (voluntarily or otherwise) and then converted to long-term residential use, there are adjustments required for GST purposes.
• The quantum and timing of these adjustments differs depending on the circumstances of the property owner and their plans for the property.
For example, it may be that you elect to, or need to, de-register for GST. The impact of this is significant because de-registering triggers a deemed sale at market value, i.e. GST to pay on current value. Usually if you cease a taxable activity for a 12-month period you are required to de-register (and face this deemed sale). However, IRD has recently announced a Covid related concession whereby you can remain GST registered if you expect to resume the short-term stay activity within 18 months (but there are conditions attached).
If the change in use is temporary only, then you can avoid de-registering and triggering this deemed sale. However, you will likely need to apply the complex change in use adjustment rules. These rules see you paying GST back on the asset based on the period rented short stay vs long stay, as a proportion of the total period owned. This causes you to make an adjustment on a so-called “period by period” basis, repaying a portion of GST at the end of each financial year. Confused? Don’t worry, you can (and probably should) use an accountant for this calculation, to avoid issues with IRD.
One thing to be crystal clear on when renting a property to a residential tenant is that you do not charge/pay GST on the rent. I say this, because I have seen a few accountants over the years making their clients do so. This is incorrect. Rent from long-term residential tenancies is always exempt from GST – even when you are building houses for re-sale. Keep your eyes skinned for accountants mucking this up; I seem to see it around the country a bit. If you are paying GST on rental income, then you should seek an alternative opinion, or challenge your tax practitioner on this point.
Summary
In summary, there are consequences from both income tax and GST perspectives in converting a property from short-term to long-term residential use. Such a change can bring the loss ring-fencing rules into play, and there can be GST to pay if the property is in the GST net (due to the prior short stay activity ceasing). As always, this is an area where it is best to get specialist advice. Talk to us at GRA if you need help - phone +64 9 522 7955, email info@gra.co.nz or fill out our online form.
Matthew Gilligan
Managing Director and Property Services Partner
© Gilligan Rowe & Associates LP
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Disclaimer: This article is intended to provide only a summary of the issues associated with the topics covered. It does not purport to be comprehensive nor to provide specific advice. No person should act in reliance on any statement contained within this article without first obtaining specific professional advice. If you require any further information or advice on any matter covered within this article, please contact the author.
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