There’s been some confusion about proposed changes to the tax treatment of rental losses. Many taxpayers have been a bit panicky, under the impression that the changes are already in force.
While it seems to be fairly certain that these changes will come in, until the law passes they are not in operation. The legislation to make this happen is still in process. It is still being debated and may see further changes. We’ll keep you informed about developments.
The proposed new rules are expected to apply from 1 April 2019 for the 2019/20 and later income years. They will not apply to a deduction a person is allowed for a prior income year.
Rental losses can’t be offset against other income
The proposals mean that, for rental properties that make losses, owners will no longer be able to offset those losses against other sources of income such as salary or wages.
However, owners who incur losses on their rental property will be able to carry those forward and use them against future income or profits from that property. Owners with more than one property can also use those losses to offset income from other rental properties.
What property is subject to these rules?
The proposals apply to ‘residential rental property’:
- land that has a dwelling on it
- land on which the owner has arranged to build a dwelling, or
- bare land that may be used to build a dwelling under the relevant operative district plan
What property is NOT subject to these rules?
The proposals do not apply to property that is:
- used predominantly as business premises, or farmland
- a person’s main home
- land subject to the mixed-use assets rules (such as a bach that is sometimes used privately and sometimes rented out)
- land owned by a widely-held company
- accommodation provided to employees or other workers because of remote location or equivalent reason
- land identified as taxable on sale (such as land held in dealing, development, subdivision, and building businesses, and land bought with the intention of resale), provided that:
– the taxpayer notifies IRD of their rental income and expenditure on a property-by-property basis, or
– the taxpayer notifies the IRD of their rental income and expenditure on a portfolio basis and all of the properties within the portfolio are on revenue account.
Offsetting rental losses within a portfolio
If you own more than one rental property, under the proposed new rules ring-fencing of deductions applies on a portfolio basis. Essentially that means you can offset deductions for a specific rental property against income from other rental properties in your portfolio. You can also offset losses against income from the sale of residential property if it is taxable (for example under the bright-line test) to the extent of bringing the gain down to zero. After a property is sold, any unused deductions would continue to be ring-fenced and carried forward to be used against future residential income or offset against other residential lands that are taxable. However, if all of the property within the portfolio is sold and was taxable on sale, any unused deductions at that point can be used to offset against other income (including wages or salary).
If you don’t want to proceed on a portfolio basis, you can elect to use a property-by-property basis.
Offsetting rental losses property-by-property
If you want to offset deductions for a specific property against future income or taxable gain from that same property, you must elect to do so. You do this by notifying the IRD in your income tax return that you are applying the ring-fencing rules on a property-by-property basis. The 2019/20 income year is the first year you will be able to do this. For any property acquired after that, the election to use the property-by-property basis must be made in the relevant tax return in the year the property is purchased.
If you use the property-by-property basis, you must set out income and deductions relating to each specific property in your returns to Inland Revenue. When the property is eventually sold, at that point any unused deductions can be used to offset other income (including salary or wages).
Transfer between companies in a wholly-owned group
Where you own multiple companies, and those companies’ assets include residential property, it will be possible to transfer rental losses from one company to another. The deduction would only be able to be used by the transferee company with regard to residential rental income (or the sale of residential land that is taxable). Note that the companies must belong within a wholly owned group.
Some businesses do run complex entity structures involving companies, trusts or partnerships alongside the actual people at the heart of the business.
The people drafting the ring-fencing proposals saw early on that some investors would try to be clever by separating losses and income into separate business entities.
For instance, where a person takes out a loan to buy shares in a company that then buys a residential property, in theory the person could claim deductions on the interest because the loan relates to investment in shares rather than buying a rental property. The person could then offset those deductions against other income (such as salary or wages).
This loophole for so-called ‘interposed entities’ has been closed with provisions for ‘residential land-rich entities’. The proposed rules for interposed entities apply not only to companies, but also to trusts, partnerships and look-through companies.
The proposed new rules are horribly complicated in the fine detail and have some way to go before they are actually law. We will stay in touch with you about it. In the meantime, don’t hesitate to contact us if you:
- want to discuss likely scenarios for your current rental investments
- are thinking about buying or selling rental property
- will be arranging finance or refinancing your rental property
Call us on (06) 878 8824.