Loss Ring-fencing on Rental Properties

Loss Ring-fencing on Rental Properties

Loss Ring-fencing on Rental Properties

The government has just introduced their long signalled changes to rental property tax into Parliament. They propose introducing loss ring-fencing on residential rental properties, just in time for Christmas!

The proposed bill can be best be described as complex, but we have tried to give a flavour of the proposed changes below.

What Changes are proposed?

For years, residential property investors have been able to use losses on rental properties to offset their personal tax.

Residential rental properties are often “negatively” geared. This means that the expenditure exceeds the income, resulting in a loss.

The government proposes ring-fencing these losses and preventing investors from using any losses against their personal tax.

How will it work?

At its most basic, any losses will be carried over to the next income year. No PAYE refund will be issued to the investor.

The losses won’t be able to be utilised until the investment makes a profit.

The ring-fencing will apply on a portfolio basis, so if an investor has more than one property, losses on one can be offset against profits on another.

Interestingly, there is the option to opt out. Investors can ‘elect’ to have any losses ring-fenced on a property by property basis. This could be useful for portfolio investors if the ring-fences losses on a property are likely to exceed any gain when sold, however how this could be foreseen is anyone’s guess.

For many investors, it will take some time to pay down a mortgage before the investment becomes profitable. The ring-fenced losses won’t be utilised until quite some time in the future.

What can losses be utilised for?

  • Future residential income and;
  • Any income on the sale of residential land e.g. any capital gain caught under the Bright-line test rules.

Losses can’t be used to offset income from other investments.

What about Trusts? 

Trusts will also have losses on residential properties ring-fenced.

These losses won’t be able to be applied against other income, such as shares or managed funds.

How does it impact Look Through Companies? 

Losses will no longer flow through to the shareholders automatically to generate a refund.

Losses will be allocated to the shareholders to be used against future profits from residential properties.

And Closely-held Companies? 

Losses will be ring-fenced in exactly the same way.

However, the shareholder continuity rules will apply when a shareholder reduces their shareholding. This means that the losses can be forfeited, often quite unintentionally.

Where there is more than one company in a group, the losses will be able to be transferred to another company, but only if the companies in the group have identical shareholder(s) i.e. they are wholly owned.

What property is excluded?

  • A taxpayer’s main home if they are renting out part of it;
  • Mixed-use assets as there are already specific rules on these;
  • Any property that was bought from the outset with the intention of resale;
  • Certain accommodation provided for employees, and:
  • Property owned by ‘widely-held’ companies (e.g. 25+ shareholders).

When is it intended to take effect?

Assuming that the bill passes through all stages in Parliament unchanged, the legislation will come into force from 1 April 2019.

The bill is now in Select Committee.

Submissions closed on 28 February 2019.

What’s our view?

We believe that ring-fencing is not good tax policy. It means that one sector of the economy is being treated quite differently from the others.

We also believe that the compliance costs and administration will be high.

As with all tax changes, there are always unintended consequences.

We believe this law change will have an impact on residential housing stock with some investors opting to leave the market. This was certainly the experience when a similar scheme was tried in Australia back in the 1980s. The Hawke-Keating government briefly introduced ring-fencing in 1985 only to restore full negative gearing in 1987.

There is a real risk that those investors left in the market will increase rents.

An IRD commentary on the proposed change is available by clicking here.

The information produced above is based entirely on proposed legislation and is subject to change at any stage. It should not be relied upon as tax advice. Tax advice should always be sought from a professional and tailored to your specific circumstances. 

Angus is the CEO and founder of Generate Accounting.