Why ring fencing rental losses are being introduced

Auckland residential market has been hot topic for several years. It has been going in only one direction upwards. The Government has been trying to make changes in tax policies since 2010. Firstly, they abolished LAQC, and depreciation on building, then introduced bright line test. Currently the bright line test has been extended to 5 years from April 2018 onwards, and Ring fencing of rental losses are being introduced from April 2019.

What is ring fencing rental loss

In New Zealand you pay tax on your net income from all sources. It means net income is calculated by total of salary & wage, rental income/loss, business income/loss, dividend, interest, overseas income/loss etc. If you make loss in any activity that loss is offset against income from other activities, and income tax is calculated on the net income. Going forward, the government is eliminating the loss produced by residential investment to offset against other types of income.

Why ring fencing rental losses are being introduced

In general people buy residential investment property with a view of capital gain in long term. However, when in short term it produces losses (expenses are more than the income) then the rental losses are offset against employment income. The net effect of which is tax refund. The Government, view is the tax policies are favoring to buy residential rental investments. They also view that people make capital gains from investing into residential investments, and the capital gains are not taxed.  They are trying to use tax policy as a tool to discourage people to invest into residential rental investments.

From when the new rules are effective.

Currently the IRD is seeking submission on their proposal due date of which is 11-05-2018. They are looking to make it effective from 01-04-2019. The rules could either apply in full from the outset, or they could be phased in over two or three years.

Which properties the new rules apply to

These rules only apply to residential rental investment and DO NOT apply to:

• a person’s main home;

• a property that is subject to the mixed-use assets rules (for example, a bach that is sometimes used privately and sometimes rented out); or

• land that is on revenue account because it is held in a land-related business

How it works

·         This will apply on a portfolio basis. It means investors would be able to offset losses from one rental property against rental income from other properties – calculating their overall profit or loss across their portfolio.

·         Ring fenced losses from one year could be offset against residential rental income for future years.

·         “Residential land” is not limited to land in New Zealand – it would extend to overseas land.

·         It was discussed to create interest allocation rules, as people can use debt funding for some type of assets and equity funding for residential rental investments. They also discussed, specific interest allocation rules would create considerable complexity and compliance cost. The small taxpayer and business would suffer the most who use their residential investments for business funding. Thus, specific interest allocation rules are not being proposed.

·         It applies to all entities, including Trust, Company, LTC and individuals

·         A specific rule to deal with the interposing of entities will be created. People can not get around by structuring differently, for example you invest in a company, which then buys residential rental investment. Since, you have invested in shares, under current rules the cost of borrowing is your expense, but this will not be allowed.

·         A suggest approach to deal with interposed entities is to define “residential property land rich”. It is proposed when an entity owns over 50% investments into residential properties ring fencing of losses would be applicable.

       {proforms 1}