Rules to “ring-fence” losses from residential properties are to apply from 1 April 2019. The aim of these rules is to prevent the owners of residential properties from offsetting losses from these properties against other sources of income, such as salary and wages or business and investment income, thereby reducing the person’s tax liability.
The ring-fencing of losses will apply to “residential land.” This is the same type of land that is subject to the bright-line test. Residential land is land that has a dwelling on it, land for which there is an arrangement to erect a dwelling on it; or bare land on which a dwelling may be erected under the relevant district plan. It excludes land used predominantly as business premises and farmland.
As with the bright-line test, there is an exclusion for a person’s “main home”. There are also several other exclusions, including:
- Land subject to the mixed-use asset rules; e.g. a holiday home that is rented out when not used by the owner.
- Land held as part of a business of dealing, developing, subdividing, or erecting buildings on land.
The default position is that ring-fencing will apply on a portfolio basis, meaning that investors would be able to offset losses from one residential rental property against the income from other residential rental properties. Under the rule, deductions relating to residential land can only be offset against income from residential land, such as rent and the proceeds of selling the land (should they be taxable). When the total deductions for the portfolio exceed the total portfolio income, the excess deductions are ring-fenced and carried forward to the next income year to be offset against future income from the portfolio of residential properties. When the entire portfolio of residential properties is sold, any remaining ring-fenced loss may, in very limited circumstances, be released from the ring-fence and can be offset against the taxpayer’s other income. Losses that are not released continue to be carried forward and can be to offset against income from other residential properties the taxpayer already owns or may acquire in the future.
Taxpayers have the option of applying the ring-fencing on a property-by-property basis. Electing on a property-by-property basis means the deductions relating to a property can only be offset against income from that property. When the deductions for one property exceed the income from that property, the excess deductions cannot be offset against the income from another residential property and must be carried forward. There will be circumstances when electing a property-by-property basis is preferable to applying a portfolio basis.
Special rules will also be introduced to ensure the ring-fencing rules cannot be avoided by using a trust, company, look-through company, or partnership. Where funds are borrowed to invest in a “residential property land rich” entity, an entity where over 50% of its assets by value are residential properties, interest on the borrowings will be considered “rental property loan interest” and be subject to the ring-fencing rules.
To find out more about how ring-fencing might affect you, please contact your Crowe Horwath adviser.
Technical Director – Tax Advisory