Ring-Fencing Residential Rental Property Losses
Inland Revenue has released an issues paper that proposes the introduction of a loss ring-fence for residential rental properties. Ring-fencing simply means that losses from a trade can only be set off against income from the same trade. Under the proposal, residential property investors will no longer be able to offset losses from their residential properties against their other income (for example, salary or wages, or business income), to reduce their income tax liability.
The Government has committed to several policy measures that it considers will make the tax system fairer and improve housing affordability for owner-occupiers by reducing demand from speculators and investors. The Government expects the introduction of loss ring-fencing rules will help level the playing field for property speculators/investors and home buyers. The Government considers that investors (particularly highly-geared investors) have part of the cost of servicing their mortgages subsidised by the reduced tax on their other income sources, helping them to outbid owner-occupiers for properties. The Government intends the proposed ring-fence for residential property losses to reduce this advantage and perceived unfairness.
The Government is proposing that the loss ring-fencing rules will apply to “residential land”. The definition of “residential land” that already exists for the bright-line test will apply. The rules would not apply to a person’s main home, a property that is subject to the mixed-use assets rules (e.g. a holiday home that is also used to generate rental income), or land that is subject to tax on sale because the person holds it as part of a dealing or developing business.
The proposal is for the loss ring-fencing rules to apply on a portfolio basis. This would mean that investors would be able to offset losses from one rental property against rental income from other properties – calculating their overall profit or loss across all the rental properties owned. An investor will be able to offset ring-fenced residential rental losses from one year against residential rental income from future years (from any property) and taxable income on the sale of any residential land.
Inland Revenue acknowledges that avoidance rules will be required to prevent structuring around the proposed ring-fence. For example, Inland Revenue makes specific mention of a need to prevent investors circumventing the rules by borrowing funds to acquire shares in a company, or to fund a trust or other entity, that acquires residential investment properties.
The proposed start date for the ring-fencing rule is the start date of the 2019-20 income year (1 April 2019 for most taxpayers).
The impact of the ring-fencing rule is something to keep in mind if you own or are considering investing in residential rental properties.
For more information, speak with your Findex adviser.