The Tax Treatment of Mortgage Cashbacks on Investment Property Loans
Bank cash incentives, often referred to as mortgage cashbacks or cash contributions, have become increasingly common in New Zealand. Property investors refinancing existing lending or purchasing a new rental property may receive thousands of dollars from the bank as an incentive to move their borrowing.
Many investors assume these payments are simply "free money" and therefore have no tax consequences.
Unfortunately, the position is not quite that simple.
Recent draft guidance from Inland Revenue suggests that while a cash incentive is generally not taxable when it is received, it can have tax consequences later if the loan relates to an income-producing property such as a rental.
What Is a Bank Cash Incentive?
A cash incentive is a payment made by a lender when you take out or refinance a mortgage.
Examples may include:
Cashback payments
Cash contributions
Refinancing incentives
Loan establishment contributions
The money is often used to cover:
Legal fees
Valuation costs
Moving expenses
Renovation costs
General cash flow
For property investors, these amounts can often range from several thousand dollars to tens of thousands of dollars on larger lending facilities.
Is the Cashback Taxable When You Receive It?
Generally, no.
Inland Revenue's draft guidance indicates that a bank cash incentive does not have the characteristics of ordinary income and is therefore generally not assessable when received.
This means that if a property investor receives a $10,000 cashback from their bank upon settlement or refinance, they do not typically return $10,000 as income in that year's tax return.
However, that does not mean the payment can be ignored forever.
Why Property Investors Need to Be Careful
Most rental property loans fall within New Zealand's financial arrangement rules. Inland Revenue's draft position is that the cashback forms part of the overall financial arrangement and may need to be taken into account when that loan comes to an end.
This could occur when:
The loan is repaid.
The property is sold.
The loan is refinanced.
The lending is restructured.
The mortgage is switched to another bank.
At that point a calculation known as a Base Price Adjustment (BPA) may be required.
How the Adjustment Works
In simple terms, the cashback effectively reduces the overall borrowing cost of the loan.
As a result, some of the interest deductions claimed over the life of the loan may effectively be reduced when the arrangement is brought to an end.
Example 1 - Assume:
Cashback received: $10,000
Interest paid in the final year of the loan: $15,000
Under Inland Revenue's draft guidance, the BPA calculation would generally produce a net deductible amount of $5,000.
Example 2 - Assume:
Cashback received: $10,000
Interest paid in the final year: $7,000
The BPA calculation could result in taxable income of $3,000.
Consequently, the tax impact might not arise until many years after the cashback was initially received.
What About Owner Occupied Homes?
This issue is generally more relevant for property investors than owner-occupiers.
Where a loan is purely private, such as funding a main residence, the practical tax consequences are usually limited because the interest is not deductible in the first place.
For rental property owners, however, the loan is connected to an income-producing activity, which is why the financial arrangement rules become relevant.
Mixed-Use Properties Can Become Complicated
The position becomes less straightforward when the property's use changes over time.
For example:
A family home later becomes a rental property.
A rental property later becomes a main residence.
Part of the property is used for business or home office purposes.
Borrowings are redrawn for different purposes.
In these situations, specialist advice is worthwhile as the eventual BPA calculation may be more complicated than a straightforward rental property loan.
Practical Tips for Property Investors
If you receive a cash incentive from a bank:
Keep Good Records
Retain:
Loan agreements
Refinance documents
Cashback correspondence
Settlement statements
Evidence of property use
The tax effect may not arise until years later when the loan is repaid or refinanced.
Consider It When Refinancing
When comparing mortgage offers, do not focus solely on the cashback amount.
Also consider:
Interest rates
Break fees
Legal costs
Clawback provisions
Future tax implications
Seek Advice Before Major Restructures
Refinancing, trust restructures, property transfers, or significant debt reorganisations can all potentially trigger financial arrangement consequences.
Obtaining advice beforehand can help avoid surprises.
Key Takeaway
Many property investors assume a mortgage cashback is simply free money.
While Inland Revenue's current draft position indicates the payment is generally not taxable when received, the position changes when the loan relates to an income-producing property. In these situations, the cashback may eventually need to be recognised through the financial arrangement rules when the loan is repaid, refinanced, or otherwise comes to an end.
One additional point is that the above assumes the borrower is a cash basis person. Investors who are required to apply the accrual spreading rules under the financial arrangement regime may need to spread the cashback over the term of the loan, resulting in a different tax treatment.
The lesson for property investors is simple:
Enjoy the cashback, but don't forget about it. The tax consequences may not arise until years later.
Disclaimer: This article is based on Inland Revenue's draft guidance on cash incentive payments and is intended as general information only. The final published position and the tax outcome for individual investors may differ depending on the specific facts and circumstances