Difference between residential and commercial properties

Residential properties are typically homes or apartments. These might be family houses, townhouses, studios, etc. Investors in residential property market rent out the properties on a long-term basis. This type of investment is exempt for GST purposes, which means you do not pay GST on rental income from long-term residential renting, nor claim GST on the long-term residential expenses.

Commercial property, on the other hand, is any property not primarily used as a residence, for example retail spaces, office spaces, commercial units such as warehouses etc. Investors in such properties usually lease them out to other businesses or they may run a business out of their own space. With Commercial properties, the related income and expenses are subject to GST, so investors need to manage their GST filing with Inland Revenue either by themselves or through their tax agencies.

Expenses you can claim

Property investors can claim deductions while properties are rented or available for rent. One main tax difference between commercial and residential buildings is that investors can claim depreciation on commercial properties.

The depreciation rate for all buildings had been reduced to 0% in 2010. The Government then reinstated depreciation on commercial buildings as part of Covid-19 support in 2020, so depreciation can now be claimed on commercial and industrial buildings from the beginning of the 2021 income year. The reinstatement will mean commercial and industrial buildings are now depreciated at 2% diminishing value or 1.5% straight-line. Residential buildings continue to have a 0% depreciation rate.

The other main difference between commercial and residential buildings for cost deductions is the ability to deduct loan interest. Interest costs on commercial property ownership are tax deductible. On the other hand, the government introduced new rules phasing out the ability to deduct loan interest from residential rental income in year2021. The phasing out of interest deductibility will be backdated to apply from 1 October 2021:

• Residential rental property purchased on or after 27 March 2021, interest cannot be claimed as an expense from 1 October 2021, unless an exclusion or exemption applies.

  
  

• For property acquired before 27 March 2021, the ability to deduct interest on existing loans is being phased out over 4 years, ending 31 March 2025.

Income year and percentage of interest claimable

1 April 2020 – 31 March 2021 –100%
1 April 2021 – 30 September 2021 – 100%
1 October 2021 – 31 March 2022 – 75%
1 April 2022 – 31 March 2023 – 75%
1 April 2023 – 31 March 2024 – 50%
1 April 2024 – 31 March 2025 – 25%
1 April 2025 onwards – 0%

• Interest deductions for any new loans drawn down on or after 27 March 2021 is not allowed from 1 October 2021 onwards.

There are exemptions applying to certain types of residential accommodation, such as business premises, farmland and new builds etc. For new builds (a property that received its code compliance certificate on or after 27 March 2020), interest is eligible to be deducted for up to 20 years from the time the property’s code compliance certificate is issued.

Bright-line Test

The bright-line rule means that if you sell a residential property within a set period after acquiring it, you will be required to pay income tax on any profit you made through the property increasing in value. Properties that have been the owner’s main home for the entire time they owned it are exempt from the rule. The bright-line property rule does not apply to commercial properties.

Last but not least, investors should discuss with their accountants regarding the ownership structure for their investment during the due diligence process.

The comments in this article are of a general nature and should not be relied on for specific cases, where readers should seek professional advice.

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