Changes for residential rental owners from 1 April 2019
Tax Alert - March 2019
By Robyn Walker and Blake Hawes
As the media and commentators continue to have a field day analysing the recommendations in the Tax Working Group Final Report and its majority position advocating a capital gains tax, a different set of new rules which will affect many residential landlords is close to implementation and requires some serious thought.
The Taxation (Annual Rates for 2019-20, GST Offshore Supplier Registration, and Remedial Matters) Bill which was introduced to Parliament on 5 December 2018 includes fundamental changes to the treatment of residential rental property losses as one of its “remedial matters”.
These new rules have an intended application date of the start of the 2019-20 income year. And if you’re wondering whether that application date seems alarmingly close, you’d be correct. As most residential rental property owners are likely to have a standard 31 March balance date, these rules will apply from 1 April 2019.
To put it simply
The proposed legislation intends to end landlords offsetting losses incurred on residential rental properties against other sources of income (for example salary or wages and investment income), which generally results in a reduced tax liability and in many cases an income tax refund.
Any losses should not be permanently lost, instead they are ‘quarantined’ and can be carried forward and offset against any future income derived from residential rental property, and in some cases this could include any taxable income arising from the sale of the property itself.
What you need to know
While these rules are still to be enacted and therefore are subject to change, the key features of these rules and what may need considering if you own a residential rental property are:
- Property affected by the changes will only be “residential rental properties” which are on “residential land” and the rules will not apply to any land that is your main home, a mixed use asset or property that will be taxed on sale under the ordinary land sales rules, such as land purchased with the intention of resale which is rented out in the interim. This doesn’t provide an out for property which simply may be taxed, for example if it is sold within the 5 year bright-line period.
- “Residential land” is not restricted to land in New Zealand. Land anywhere in the world will potentially be subject to these rules.
- Taxpayers with more than one rental property who wish to treat their rental properties on a property-by-property basis will be required to make an election to Inland Revenue or the default position of a portfolio basis will be deemed to have been chosen. This choice can have an impact on the use of ring fenced losses and should be considered carefully. For existing landlords, an election must be made with the tax return for the 2019/20 income year.
- Particular provisions will apply to prevent taxpayers using interposed entities to avoid the application of the proposed rules. The use of a company between the taxpayer and the residential rental property would be caught if the company was considered to be “land rich”.
It is worth noting that these rules will not apply to widely-held companies (those with 25 or more un-associated shareholders).
Thought should be given to
The choice to treat rental properties on a portfolio basis or property-by-property basis isn’t necessarily a straightforward one. It may depend on the expectation of what will happen in the event of property being sold.
- The portfolio basis (the default option) will allow a taxpayer to treat all of their properties as if they were one. This will allow an offset of expenses against income across all rental properties in a portfolio. In the event that property is taxable on sale (for example if it is sold within a 5 year or 10 year period, as applicable), carried forward losses can be used to offset any taxable gain on the sale to nil. In the event that an entire portfolio of property is sold, any remaining carried forwarded losses would be left stranded unless the entire portfolio was taxable on sale.
- The property-by-property basis will not allow expenses from one property to be offset to income from another. However, if any of the properties in the portfolio becomes taxable on sale, the ring fenced losses for that property will be accessible to the taxpayer to offset against other income.
The provisional tax rules may apply to certain taxpayers who previously used rental property losses to reduce their income tax liability. If without rental property losses your residual income tax liability may be higher than $2,500 consideration will be required to determine provisional tax obligations and effort will be required to manage these payments of tax going forward.
Given the spotlight rental properties have been given in the last year and the changing legislative landscape we recommend consulting your tax advisor to make sure you have your head around all the changes before they take effect next month.
March 2019 Tax Alert contents