Why Ring-Fencing will Punish Residential Property Investors

This article discusses how the proposed legislation to “ring-fence” residential rental losses could negatively affect residential property investors.

The current governments is committed to pursue it pre-election promise to “ring-fence” rental losses. It apportions blame for the housing price inflation squarely on residential property investors and speculators. Its policy ignores the true cause of house price inflation.

The real reason for inflated property market prices was due to heaps of cheap credit being available after the 2008 global economy crisis. Central governments and banks were aiming to stimulate the global economy.

Government Policy

Despite this, the government seems willing to pursue punitive policies that could stop residential property owners from offsetting rental losses against other income. In March 2018, the Treasury Department and Inland Revenue issued a combined Paper on ring-fencing rental losses. The Paper reinforced the Finance Minister’s ideas outlined in his budget speech.

Although the paper didn’t impose any immediate rules, the Minister proposed that they would become effective in April 2019. The proposed changes focus only on residential property investors.

This example outlines how the proposed ring-fencing rules could work.

ABC Limited, a Look-Through-Company, owns a residential investment property in Parnell. It purchased it for $1.1m and receives $800 rental income per week. The property was secured with a 100% interest only loan, using the rental property and shareholders’ family home as security.  The property generates $41,600 income per year and incurs $55,279 expenses, resulting in a loss of $13,679 for the year.

Current Legislation

Under current legislation, ABC Limited’s shareholders can offset the $13,679 loss against any other income that they may have. For example, if the shareholders earn $180k between them for the year, they would pay tax on $166,321 and quite probably receive a tax refund. However, from 1 April 2019, they would need to carry forward the $13,679 loss, rather than receive a tax refund.

While this will impact many residential property investors, it’s not all negative news – especially if you hold a portfolio of residential properties. The Paper outlines proposals to apply the ring-fencing rules on a portfolio basis. In other words, losses from one property can be used to offset those from another property you also own.

For example: The shareholders also owned a property in Dunedin, which made a $9,000 profit. They will be able to offset the $13,679 loss on their Parnell property. A net loss of $4,679 would be ring-fenced and carried forward to be used to offset future profits.

Many have described that this ability to offset losses against other non-residential income is a tax-loophole. Also, this “loophole” is generally available to everyone, so there’s a strong argument that it isn’t a “tax loophole” if it’s available to everyone.

The Paper seeks to make it much more difficult to structure a person’s business affairs to avoid the legislation. Currently, a residential property investor can borrow funds to buy the shares in a company that invests in residential properties. They can then offset the interest deduction against their other income.

The proposed legislation seeks to prevent this by treating these type of interest expenses as belonging to the rental property and not the shareholders.

Conclusion

In my opinion, the proposed legislation will punish investors for preferring to invest in residential property rather than other investment types. If you’re a residential property investor, this legislation is likely to affect you. You may like to address any repairs and maintenance issues before the legislation becomes statutory on 1 April 2019.

Download the Paper from http://taxpolicy.ird.govt.nz/publications/2018-ip-ring-fencing-losses/overview. Mark Gwilliam is a Director at Business Advisory Accounting & Tax Services. Contact him on 027 449 0417 or at markg@bizadvice.co.nz to discuss how your residential rental losses may be affected.

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