Ring Fencing of Rental Losses
Loss Ring-fencing on Rental Properties
The government has introduced their long signalled changes to rental property tax into Parliament.
The proposed bill can best be described as complex, but we have tried to outline the proposed changes below briefly.
What Changes are proposed?
For years, residential property investors have been able to use losses on rental properties to offset their personal tax.
Residential rental properties are often “negatively” geared. This means that the expenditure exceeds the income, resulting in a loss.
The government proposes ring-fencing these losses and preventing investors from using any losses against their personal tax.
How will it work?
At its most basic, any losses will be carried over to the next income year. No PAYE refund will be issued to the investor.
The losses won’t be able to be utilised until the investment makes a profit.
The ring-fencing will apply on a portfolio basis, so if an investor has more than one property, losses on one can be offset against profits on another.
Interestingly, there is the option to opt out. Investors can ‘elect’ to have any losses ring-fenced on a property by property basis. This could be useful for portfolio investors if the ring-fences losses on a property are likely to exceed any gain when sold, however how this could be foreseen is anyone’s guess.
For many investors, it will take some time to pay down a mortgage before the investment becomes profitable. The ring-fenced losses won’t be utilised until quite some time in the future.
Bear in mind that this will apply to residential rental property anywhere in the World, not just in New Zealand.
What can losses be utilised for?
Future residential income and;
Any income on the sale of residential land e.g. any capital gain caught under the bright-line rules.
Losses can’t be used to offset income from other investments.
What about Trusts?
Trusts will also have losses on residential properties ring-fenced.
These losses won’t be able to be applied against other income, such as shares or managed funds.
How does it impact Look Through Companies?
Losses will no longer flow through to the shareholders automatically to generate a refund.
Losses will be allocated to the shareholders to be used against future profits from residential properties.
And Closely-held Companies?
Losses will be ring-fenced in exactly the same way.
However, the shareholder continuity rules will apply when a shareholder reduces their shareholding. This means that the losses can be forfeited, often quite unintentionally.
Where there is more than one company in a group, the losses will be able to be transferred to another company, but only if the companies in the group have identical shareholder(s) i.e. they are wholly owned.
What property is excluded?
A taxpayer’s main home if they are renting out part of it;
Mixed-use assets as there are already specific rules on these;
Any property that was bought from the outset with the intention of resale;
Certain accommodation provided for employees, and:
Property owned by ‘widely-held’ companies (e.g. 25+ shareholders).
When is it intended to take effect?
Assuming that the bill passes through all stages in Parliament unchanged, the legislation will come into force from 1 April 2019.
The bill is now in Select Committee.
Submissions closed on 28 February 2019.
The information produced above is based entirely on proposed legislation and is subject to change at any stage. It should not be relied upon as tax advice. Tax advice should always be sought from a professional and tailored to your specific circumstances.