Background
At 26 June 2019, the new Property Ring-Fencing Rule received Royal Assent, back-dated to take effect from 1 April 2019. The legislation change seeks to prevent property investors from investing for capital gain: a tactic supposedly used by investors who make consistent losses. Because New Zealand does not have a capital gains tax as such, the new rules seek to plug this “loophole”.
How does ring fencing work?
The new legislation means that if a rental property makes a loss, the losses on that rental property carry forward to a later tax year. For example, if the rental income on a property is $25,000 and rental expenses are $35,000, only $25,000 of the deductions can be claimed. The $10,000 difference will be carried forward to future tax years and can only be used against future residential rental property income – not other income earned.
The rental profit or loss can be calculated on a portfolio approach (in which all rentals are lumped together) or on a property-by-property approach. The default is the portfolio approach, which will also be more practical from a compliance cost perspective.
What do the new rules apply to?
The rules apply to residential rental property and residential land, but specifically exclude:
- A main home
- Property on “revenue” account (bought for resale and taxable, such as a “do-up”, flick or development)
- Mixed-use asset (rental and private property, empty for 62+ days a year; e.g., a holiday home)
- Employee accommodation
‘Residential land’ includes land with a dwelling or an arrangement to erect a dwelling, but excludes business premises and farmland.
The devil is in the detail
Certain rules will now apply to lifestyle blocks and dual-use properties (where commercial premises and a dwelling are in the same building). Rental income from land held on revenue account will be included in the portfolio approach under the new rules, rather than being specifically excluded. This detail may catch a lot of people out.
Also, if the taxpayer incurs costs such as bank fees and accounting fees which relate to both residential rental income and other income, apportionment may be required.
The new rules are somewhat complex, particularly when it comes to tracking historical disposals and the tax effect on excess deductions carried forward from previous years.
Keeping detailed records will be essential. Switching between accountants may result in important details not being passed on.
Some taxpayers may never be able to claim certain excess deductions; some deductions can only be claimed against residential property income (including taxable income on disposal of residential property).
What do these rental property tax changes mean for property investors?
- Ensure your accountant applies the new rules correctly
- Invest for yield, not tax breaks
- LTCs may be less useful in future
- Family Trusts may be used more to hold residential rental investments.
The Bright Line Test and now new Ring Fencing rules mean it’s a complex world out there for rental property investors.
If you’re thinking of restructuring, buying or selling property, be sure to seek expert advice first. Give Q2 a call today for comprehensive advice and information.