Ring-Fencing of losses – What does it mean for investors
There has been a lot of debate over the claiming of rental losses and whether this method of taxation should be allowed by investors.
Our Governments view is that, with property prices having reached their current peak, they are out of reach for the average kiwi and something needs to be done about it. The government’s view is that now is the time to bring in a method called “ring-fencing”. This essentially means the off-setting losses incurred in private/company owned rental properties throughout the course of business against one’s personal income.
A paper has been released by the Inland Revenue Department stating that ring-fencing will level the playing field between speculators, investors, and home buyers. This will mean that investors will no longer be able to offset tax losses from their residential investment properties against their other income to reduce their tax liability.
The Government sees this policy as a key measure in making the tax system fairer while improving housing affordability for owner-occupiers.
Revenue Minister Stuart Nash says “At the moment, tax is applied on a person’s net income, which means if a property investor makes rental losses those losses reduce their overall income, and therefore their tax liability.
“The persistent tax losses that many property investors declare on their investments indicate that they rely on capital gains to make a profit. Changes would make the tax system fairer by ensuring that investors could not offset their losses on some property investments against their other income,” Mr Nash says.
Here are some of the proposals:
• Losses arising from rental properties will not be able to be offset against the taxpayer’s other income. These losses often arise due to interest payable on mortgages on the rental property.
• The ring-fenced losses can be carried forward to future years and offset against future rental income or against future taxable income on the sale of the property
• Losses will be able to be offset on a portfolio basis i.e. ring-fenced losses from one property can be offset against income from another rental property
• The ring-fencing will apply to residential properties only including overseas residential rental properties
• The person’s main home will be excluded from ring-fencing, as well as properties that are held on revenue account (i.e. subject to tax on sale because of a land dealing, development or subdivision business) and properties that are subject to the mixed-use asset rules
• The rules will apply to individuals as well as trusts, companies (including LTCs), and partnerships
• The rules are intended to start in the 2019/20 income year however they may come in over a few years.
You can find out more by going to The Issues Paper found on Inland Revenue’s tax policy website: http://taxpolicy.ird.govt.nz/
In our view the method of ring-fencing will have a strong impact on mum and dad investors and new investors wanting to start their retirement nest egg. This group will typically rely on tax to counter losses in the early parts of their investment cycle due to not having a large amount of capital to put into property investing.
We are likely to see this group buying less and existing highly geared investors potentially selling up and go back to square one. However, our gut feeling is that government will implement the system of carrying forward losses incurred (if any) by investors to the time of sale of assets in the future. At that point if there are losses, than these will be off-set against profits from the sale hence lowering the tax payable on the profit made. This scenario also takes into account the possibility of capital tax being applied to all investment property. This is solely an opinion and should be taken this way.
What will happen to rents:
We definitely see rents increasing in the near future and feel that the Government under-estimate this foregone conclusion in their decision making.
Reducing the tax bill is one thing but looking at the outcome vs cost should be evaluated more in our opinion. There is likely to be a reduced supply of rental property provided by private investment which make up a huge chunk of the available rental stock. Less stock provided here will drive up rents considerably.
All in all, an increase in rents overtime will counter these effects and property as an investment will always be a coveted one. There are changes afoot but with change also comes opportunity.