By Frank Newman on 9th December 2018
This week the Labour led government introduced a Bill to Parliament that will ring-fence tax losses on rental property fom 1 April next year.
The Government’s press release says, “Currently investors with loss-making rental properties can subsidise part of the cost of their mortgages through reduced tax on other income, helping them to outbid owner-occupiers for properties. Yet these investors often make tax-free capital gains when these properties are sold. In conjunction with the extension to the bright-line test, ring-fencing losses from rental properties would make property speculation less attractive and level the playing field between property investors and home buyers.”
Here are the key elements in the Bill.
- The rules will apply on a portfolio basis, meaning that investors owning more than one rental would 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 also be able to elect to apply the rules on a property-by property basis.
- The losses can be carried forward and offset against future rental income or taxable capital gains. If there are no future profits then the benefit of the tax losses would be lost.
- The rules apply to residential investment property. They do not apply to farmland or land used predominantly as business premises.
- The ring fencing of losses on rental properties is expected to cost landlords approx $150m a year.
Essentially a presumption is being made that property speculators are not caught by either the bright-line test (buying and selling within five years) or the intention test, which doesn’t have a time limit and is assessed by the IRD on a case by case basis.
It is also being presumed that if an investor makes a loss on a residential property then it is very likely that they intend to resell to recover all of the losses from the sale and make a capital gain. While this will be true in some cases, there are many reasons why an investor incurs a loss from a rental activity. Quite often it is because of damage to property, unpaid rent, or vacancies. To prevent that loss being offset against other income is, in these circumstances, grossly unfair.
The ring fencing policy will mostly affect first time investors. Typically they have high debt, and they are most vulnerable to losses during those early years of ownership. They usually make up the loss from their day-job. As they repay debt and if rents rise, they will get to a position of being cash flow positive and start paying income tax on their annual rental income.
Established property investors are unlikely to be affected. They will continue to use the equity in their portfolio to fully finance a new loss-making rental investment, which they could then offset against the income from their other properties, to reduce their taxable income.
Given all residential property investors who sell within five years are caught by the bright-line test, there would be very few investors with resale intentions who are not already caught by the regulations. In any case, should the sale be outside of the bright-line time limit, the IRD has the power to tax any gains, if they decide resale was the intention.