RSM New Zealand

Ring-Fencing Rental Losses – a Labour Government Initiative

Hot off the tail of the extension to the bright-line test (extended from 2 to 5 years from 29 March 2018), comes an Official Issues Paper released in March 2018 that will see investors lose the ability to offset rental property losses from their income.

The Government considers that the playing field between property investors and home owners needs to be levelled taking issue that rental property investors benefit from tax losses whilst capital gains are derived tax-free.

The proposal is that ring-fencing of losses will apply to all “residential land” excluding a person’s main home, property subject to the mixed-use asset rules (such as a bach rented on occasion and also used privately), and land that is held on revenue account, i.e. land that is taxable on sale.  So the ring-fencing of losses will not apply to commercial property owners.

The rules will not only apply to individuals but will also apply to interposed entities if over 50% of that entity’s assets are residential property.  Consequently properties held by trusts and companies will also be subject to the rules.

Although losses will be ring-fenced, this will be on a portfolio basis.  So that means where an investor has more than one property, losses of one property can offset the income of another.  So calculating their overall profit or loss across the portfolio. 

Note however that where land is subject to tax, perhaps because it falls under the bright-line rules, it is suggested that any ring-fenced losses are only utilised to the extent of the taxable gain arising and cannot be applied to offsetting other income.  For example, Individual A has two rental properties with ring-fenced tax losses of $30,000.  Individual A buys and sells a third property and is subject to tax on the gain made. Suppose the investment was a bad decision and a gain on sale of only $10,000 arises.  The Government considers that the ring-fenced losses can only apply to the extent of the $10,000 of taxable income derived and thus the balance of $20,000 of ring-fenced losses will be carried forward. 

It is suggested that these changes will take place in the 2019-2020 income year, so from 1 April 2019 for standard balance date taxpayers.  Comments are invited as to whether this change should be phased in over a two to three year period.

The Government wish to level the playing field between home owners and investors, but it should never be a level playing field in the first instance.  The Government does not seem to contemplate the wider implications of such a change.  Although investors do receive a cash flow benefit, over the long term, tax will be payable as eventually, interest-bearing debt will be paid down.  So it is only a matter of timing.  If however these rules are introduced, what happens to all the investors?  Will rental property investment be depleted?  The answer is yes.  Investors assist with providing much-needed housing stock to the market.  Stock that the Government will have trouble providing on its own.   

Submissions close 11 May 2018 and if you have any comments that you would like us to include in our submissions, please contact Lisa Murphy at lisa.murphy@rsmnz.co.nz or feel free to make your own submissions at policy.webaster@ird.govt.nz.

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Authors

Lisa Murphy
Tax Partner - Auckland