As part of the government’s efforts to address the concerns around rising house prices, new tax rules on ring-fencing rental losses have been introduced. The goal of the new rules is to improve housing affordability for owner-occupiers by reducing demand from property speculators and investors.
The new ring-fencing rules came into effect on 1 April 2019 and will impact 2020 income tax returns.
What do the rules mean?
Historically when a rental property made a tax loss for its owner, this loss was available to offset against the owner’s other income – income such as salaries and certain business profits – resulting in less taxable income, and less taxes paid overall.
The new ring-fencing rules mean this loss offset will no longer be available. Any rental loss will carry forward into future years and will only be available for offset against future residential property related income.
This puts residential property losses into their own category, separate from other sources of income.
Who will be impacted?
The ring-fencing rules only apply to losses made from residential land, however there are a number of exemptions, as follows:
- Property used mainly for business or farmland
- Property subject to “mixed-used” asset rules (such as a holiday home that is sometimes used privately and sometimes rented out)
- Entities that are in land-related businesses such as land development or land trading
- Certain employee accommodation and properties owned by companies except close companies with less than 5 shareholders holding more than of 50% voting interests
What about the “bright-line test”?
The bright-line test defines profits from the sale of residential properties (main home exempted) bought after 29 March 2018 and sold within 5 years (or within two years if bought between 1 October 2015 and 29 March 2018), as generally taxable.
If you have ring-fenced property losses available at the time the bright-line profits occurred, then the losses can be used to reduce the profits.
Similarly, any loss made on a property sale subject to the bright-line test, will be ring-fenced and carried forward. It will only to be available for offset against other residential property income.
How are the rules applied?
The default position is that the rules are applied on a ‘portfolio basis’ meaning losses from one property can be used to offset profits of another property, in the same ownership. The alternative of isolating losses of one property from another is also available but it is unlikely to be recommended due to the additional compliance required, and the generally less favourable outcomes.
What about residential properties owned by trusts and companies?
Residential properties that fall under the ring-fencing rules will be impacted regardless of whether they are owned by trusts or companies. Exclusions such as the main home exclusion will also still apply.
Look-through company (‘LTC’) structures where income/losses are transferred directly to shareholders are also impacted. Shareholders can no longer offset LTC residential property losses against their other income. Instead, the losses hold their form and will be ring-fenced as if they were generated by the shareholder directly.
The ring-fencing rules also cover situations where a company or trust ownership structure is used to circumvent the rules. An example might be the use of a personal loan to buy shares in a company that owns the residential property – separating the ring-fenced income from loan interest expense. In this case if more than 50% of the company’s assets are residential properties then any income and expenses relating to the property are ring-fenced regardless of whether the expense is in the company’s name, or not.
This rule can extend to properties owned outside of New Zealand as well, meaning losses from overseas rentals might also be ring-fenced.
The ring-fencing rules are another reduction in the tax benefits previously available to property investors, following on from the removal of depreciation claims. Over time we will see if the rules have a meaningful effect on property prices, or conversely a flow on cost to residential rents.
The information produced above should not be relied upon as tax advice. Tax advice should always be sought from a professional and tailored to your specific circumstances.
If you have any questions or would like to discuss any of the changes please contact The Business Advisory Group on 09 300 6404