Ring-fencing of residential rental property losses

A tax bill released on 5 December 2018 will stop residential property investors from being able to offset excess deductions against their other income (for example, salary/wages or business income).  Instead, deductions will only reduce residential property income. 

Any excess deductions (losses) will be carried forward to reduce residential property income in future years or be used to reduce the taxable income amount (if any) on the sale of the residential property.  Any remaining unused deductions will generally continue to be ring-fenced. However, in some situations where a residential property is taxed on sale, remaining unused deductions may be released, so they can be offset against other income.

If the tax bill (The Taxation (Annual Rates for 2019–20, GST Offshore Supplier Registration, and Remedial Matters) Bill) is enacted in its current form, the new ring-fencing rule will apply from the start of the 2019/20 income year. The application date will therefore be 1 April 2019 for most residential property investors, but will be earlier for taxpayers who have early balance dates.

The proposed new rule will apply to “residential land” (in NZ or overseas), using the same definition of “residential land” that already exists for the bright-line test. However, the rule will not apply to:

  • a taxpayer’s main home;
  • residential property already subject to the “mixed-use asset” rules;
  • residential property that will be taxed on sale;
  • residential property owned by widely-held companies;
  • certain employee accommodation.

The default position will be that the rule applies on a portfolio basis, meaning that taxpayers will be able to offset deductions for one residential property against income from other properties – essentially calculating their overall profit or loss across their portfolio. However, taxpayers will be able to elect to apply the rule on a property-by property basis if they wish to apply that alternative method.

A special rule will apply to prevent an interposed entity (e.g. a company or a trust) from being used to circumvent the ring-fencing rule. This special rule would apply where someone has borrowed to acquire an interest in an entity, and in a particular income year over 50 percent of the entity’s assets are residential properties.

Any affected residential property investors might like to consider bringing forward deductible expenses (such as repairs & maintenance) to fall within the current income year so that such expenditure is not caught by the new ring-fencing rule.   

Treasury and Inland Revenue expect that the ring-fencing rule will cost residential property investors about $190 million per annum.

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