Buyer beware: ring fencing may be here
Tax Alert - May 2018
By Hiran Patel and Brendan Ng
On 29 March 2018 Inland Revenue released an officials’ issues paper Ring-fencing rental losses (the “issues paper”) (available here) outlining proposals to introduce loss ring-fencing on residential properties held by “speculators and investors”. The Government intends for these proposals to ‘level the playing field’ to make the tax system fairer, particularly for personal home buyers and individuals looking to buy their first home. While at first glance these proposals are aimed at property held by “speculators and investors”, they will in reality affect everyone that owns residential rental property.
These ring-fencing proposals come off the back of the recent extension to the bright-line test for residential property (effective from 29 March 2018), from two years to five years, and are further weapons in the Government’s arsenal for its crackdown on property speculation. For more details on the change to the bright-line test and how it will affect you and your properties, please see here, and for more details on the ring-fencing of rental losses, read on.
What do the ring-fencing proposals mean for me?
It is proposed that you will no longer be able to offset tax losses from residential properties against your other income (such as salary or wages, or business income) to reduce your overall income tax liability. You will however be able to use your losses on a “portfolio basis” if you own multiple rental properties. This means any losses from residential properties can be offset against income you earn from your residential property portfolio (but only your residential property portfolio). This means that you will need to track the profit or loss you make on each of your rental properties, excluding your main home, and only apply any of these losses to:
- Future residential rental income across your portfolio; or
- Taxable income on the sale of any residential land.
Any remaining losses would stay ring-fenced to be used in the future against this type of income.
Note that the rules only apply to residential land, being land with a dwelling on it (or for which there are plans to build a dwelling on it) and bare land that may have a dwelling built on it under the relevant local rules. Residential land does not include farmland or land predominantly used as business premises but it does include overseas land. The definition of “residential land” will be the same as what is used for the purposes of the bright-line test.
If these new rules are imposed, it will be intriguing to see if behaviours are changed and in particular whether there will be a tendency in future to invest in commercial property (or other types of investment that provides a deduction against your income), given it is not captured by these rules.
Are there any exemptions?
The rules are not proposed to apply to:
- A person’s main home (i.e. the home you are predominantly living in and with which you have the greatest connection);
- A property subject to the mixed-use asset rules; or
- Land held on revenue account by a land-related business.
The mixed-use asset exemption means that if you own a bach / holiday home that is sometimes rented out and sometimes used privately, this will not fall under the rules.
Land held by land-related businesses will also not be captured by the rule. A land-related business is one that is involved in development of land, division of land, building, or land dealing. The question of whether you fall into the category of a land-related business is another new consideration.
It is also worthwhile noting that special rules will be put in place to ensure that trusts, companies, partnerships and look-through company structures cannot be used to get around the ring-fencing rules.
When do these rules apply from?
These loss ring-fencing rules are still in proposal form – this means that they may still change, for better or worse! The issues paper notes that it is proposed to apply the new rules from the start of the 2019-20 income year, however, the actual implementation of this is still up in the air.
Inland Revenue would like feedback on whether the rules apply in full from the outset, or whether they should be phased in over two or three years. For example in a 2-year phasing scenario, 50% of residential investment losses could be used to offset other income in 2019-20, and in 2020-21 no offsetting would be allowed against other income (only against residential rental property income).
What are the consequences of these proposals?
The issue being addressed here is the supposed advantage (and perceived unfairness) that investors/speculators get by being able to use their losses from rental properties to subsidise their mortgage (through reduced tax on their other income sources), thereby enabling them to outbid owner-occupiers for properties.
Whether these proposals will address this issue remains to be seen. It has been noted in the past that previous ring-fencing regimes have proven not to be as watertight as they are intended to be, and that the lack of tax attributable to rental investments is not only limited to properties funded by debt. However, what we do know is that these proposals will add more compliance costs and you will now need to carefully track losses and profits from your rental properties to ensure that these are only used as allowed. You will also need to separately track any rental losses carried forward.
This will be an issue for companies and trusts where any residential rental properties held are incidental to their business. It is not currently clear how the rules will apply where residential accommodation is provided to employees (particularly if provided for no rent or below market value, i.e. there is no income). It is also not explicitly stated in the issues paper that the rules only apply to residential land owned by the taxpayer (i.e. could it apply to employers who have leased residential premises for employees).
A further issue is raised around investors with just one property (i.e. the mum and dad investors), who then end up selling on capital account. In this situation there may be losses that end up being trapped in respect of this property, with the only option to absorb the losses being to purchase another rental property that generates income – however no concession is allowed for this in the proposals as they currently stand.
Further, with these proposed new rules in play, will we see landlords less prepared to spend money on their properties (to avoid losses) to the potential detriment of their tenants?
So how can I have my say on these proposals?
If the operation of these proposed rules will affect you, the submission close date of 11 May 2018 should be firmly locked in your diary. The proposals are only in draft form and any feedback can help to iron out any issues you may have to make the proposals workable, and potentially reduce compliance costs that will arise from having to ring-fence losses from rental properties.
If you are preparing your own submission (which can be as short and concise as you like), these can be sent to Inland Revenue at firstname.lastname@example.org. Please contact your Deloitte tax advisor if you would like more information on this.
May 2018 Tax Alert contents
- New Zealand GST on low value imported goods announced
- Buyer beware: ring fencing may be here
- Australia’s GST on low value goods - what you need to know
- Research & development tax incentive
- Employee Share Schemes – It’s time to act
- Are you ready to file your final FBT return?
- Post-BEPS transfer pricing legislation refresh requires taxpayer action
- How non-residents can get an IRD number without a bank account
- Have your say on taxing short-term accommodation
- Recent Developments