Ring Fencing of Rental Losses

by Shawn O’Grady
4 Minute(s) to read

Ring Fencing of Rental Losses

Residential Property Investors no longer get a tax break from 1 April 2019 by using losses from rental properties to offset tax on other sources of income, such as salary and wages. Those losses will now be ring-fenced to the property portfolio.

So, what is loss ring fencing?

Ringfencing is designed to prevent a taxpayer from offsetting a legitimate tax loss from a residential investment property against other forms of taxable income. The loss from the rental property must be “ring fenced” and carried forward to be offset only against future taxable income from the rental portfolio. That income could be in the form of future rental profits or taxable income from a land transaction or Brightline disposal.

Why are they doing this?

Because they see investors gaining a tax saving from a rental loss without the requirement to declare capital gains as income. They see this as being a contributing factor to the housing crisis with first home buyers at a disadvantage when pitted against investors.

Very little has changed, but it does seem the government has been somewhat challenged by the question of whether to ring fence on a portfolio basis or a property by property basis.

 

Here’s the rub, . . .

 

The bills default position is to ring fence on a portfolio basis but there is an opt out elective option if you wish to have your loss ring fenced on a property by property basis.

Ring fencing on a portfolio basis means that if overall a property portfolio is profitable, there is no ring fencing just because some of the properties in it may make losses. This is a huge issue with the effectiveness of this legislation because it means an investor with a profitable portfolio can add a loss making property to it and still gain a tax advantage provided the portfolio overall is still profitable. But an investor buying the same property who does not have other rental income to offset the loss against is ring fenced and can’t gain the same tax saving.

With interest rates at 4%, more or less level with residential yields you don’t need much equity now to be profitable. A client survey by another firm indicated 65% of residential property investors are in fact profitable and paying tax.

This legislation therefore creates two types of residential investor, those that are profitable and can grow their portfolios continuing to gain tax advantages by offsetting losses against existing rents and those that aren’t who must suffer the effect of the ring fencing.

On first look, it’s very hard to imagine why an investor would elect voluntarily to have their losses ring fenced on a property by property basis but seemingly, the addition of this option may represent the government's attempt to somehow address the  unfairness of a portfolio based approach. Has it worked?  No.

 

Other key features of the bill

  • The bill will only apply to residential land as defined by the definition in the Brightline legislation. 
  • The rules will not apply to a taxpayer's main home
  • The rules will not apply to holiday homes subject to the mixed use asset rules where they are partially rented and partially used for private use.
  • Ring fencing will be on a portfolio basis with an elective option to apply the rules on a property by property basis.
  • Ring fenced losses will be able to be used to offset future income from residential land or taxable gains from the sale of residential land.
  • There will be anti-avoidance rules preventing deductions for interest on money borrowed to buy shares in property companies where the company's assets are 50% or more property.
  • The bill will take full effect from 1 April 2019 for the 2019 – 2020 year.
  • Losses from overseas residential properties will also be ring fenced.
  • Ring fencing will not apply to revenue account property where the proceeds of sale are definitely taxable
  • The rules will not apply to employee accommodation where the remoteness of the location of the business forces it to provide accommodation to employees

 

HAVE WE GOT YOU THINKING?

 

Give us a call on (04) 563 6965 or email: dennis@taxman.co.nz or shawn@taxman.co.nz

Keep an eye out for September’s article

 

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