THE RETURN OF THE INTEREST - At this point I’m beginning to wonder if the legislation is being drafted by the ghost of J.R.R. Tolkien.

Like Sauron, I may have been defeated by The Hobbit, but I’ve waded into the latest tome to try to dig out some precious nuggets of wisdom.

Rather than try to summarise the whole document (I’ll leave that to your bedtime reading), I’ve decided to focus on one aspect.

The SOP is mainly focused on the long-awaited interest deductibility provisions that are aimed at making investing in residential land a little less attractive. In the earlier discussion paper one of the questions asked was what should happen to the denied interest upon disposal of the land.

What we’ve ended up with (and I must remind you that this is still not the final form of the legislation, so even at this late stage it could change) is a two-fold provision that applies differently depending on whether the land is taxable under the bright-line rules, or one of the other provisions.

Land subject to the interest deductibility limitation rules is to be known by the catchy title of ‘disallowed residential property, or DRP for short.

If DRP is taxable under the bright-line rules and interest has been denied, the previously-denied interest is added to the cost of the property. On the other hand if the DRP is taxable under one of the other sections, for example CB 12, the interest becomes deductible in the year of disposal. Naturally a few other conditions apply (general permission still needs to be satisfied, and the interest must not have been denied by the private limitation or another limitation) but you get the idea.

So, let’s say you’re selling your third-best Auckland bach. It cost you $1.3m and you’re now flogging it off for the rock-bottom price of $1.5m. Under the new rules you have been prevented from deducting $100,000 of interest.

Your cost for the purposes of calculating bright-line income is now $1.4m, being the actual cost of $1.3m and the $100,000 of interest. When you file your next tax return, you include $100,000 of income from the sale ($1.5m - $1.4m). Note that if you make a loss, the residential rental loss ring-fencing rules still apply, so land taxable under bright-line still won’t give you a deductible loss.

If on the other hand you subdivided your Wanaka section and sold off a few lots, any interest denied on your DRP can be claimed as a deduction outright. Let’s say you sold 3 sections for $500,000 each for a cool $1.5m. Original cost of the land was $1.3m. Again, the new rules have prevented you from deducting $100,000 of interest. Your taxable income will be:

$1.5m - $1.3m - $100,000 = $100,000

While this looks like the same answer as the prior example, the key difference here is that if claiming the interest creates a loss, you can claim the deduction.