Saurav Wadhwa
The Auckland residential market has been a hot topic for several years.
It has been going in only one direction: Upwards.
The Government has been trying to make changes in tax policies since 2010.
Firstly, it abolished the ‘Loss Attributing Qualifying Company’ (LAQC) status and depreciation on building, and then introduced the Bright Line Test.
Bright Line Test has been extended to five years from April 2018 and Ring fencing of rental losses are being introduced from April 2019.
Ring Fencing Rental Loss
In New Zealand, you pay tax on your net income from all sources.
It means net income is calculated by total of salary and wage, rental income or loss, business income or loss, dividend, interest and overseas income or loss.
If you make loss in any activity, that loss is offset against income from other activities, and income tax is calculated on the net income.
Going forward, the government will eliminate the loss produced by residential investment to offset against other types of income.
Reason for implementation
Why is Ring Fencing Rental Loss being introduced?
In general, people buy residential investment property to make capital gain in the long term.
However, if in the short-term it produces losses (expenses are more than income), the rental losses are offset against employment income.
The net effect of this is tax refund.
The Government believes that its tax policies favour buying residential rental investments.
It also believes that people make capital gains from investing in residential investments and that capital gains are not taxed.
The Government is trying to use tax policy as a tool to discourage people in investing in residential rental investments.
New Rules and their application
When do the new rules come in to effect?
Currently, Internal Revenue Department (IRD) is seeking submission on its proposal by May 11, 2018 and is hoping to enforce it from April 1, 2019.
The rules could either apply in full, from the outset, or could be phased in two or three years.
These rules apply only to residential rental investment and do not apply to (a) a person’s main home (b) a property that is subject to the mixed-use assets rules (for example, a bach that is sometimes used privately and sometimes rented out); or (c) land that is on revenue account because it is held in a land-related business.
The Application Process
This will apply on a portfolio basis. It means investors would be able to offset losses from one rental property against rental income from other properties – calculating their overall profit or loss across their portfolio. Ring fenced losses from one year can be offset against residential rental income for future years.
‘Residential land’ is not limited to land in New Zealand; it would extend to overseas land.
It was discussed to create interest allocation rules, as people can use debt funding for some type of assets and equity funding for residential rental investments.
IRD also believes that specific interest allocation rules would create considerable complexity and compliance cost.
Small taxpayers disadvantaged
Small taxpayers and businesses who use their residential investments for business funding would suffer most. Thus, specific interest allocation rules are not being proposed.
It applies to all entities, including Trust, Company, Look Through Company and individuals.
A specific rule to deal with the interposing of entities will be created.
People cannot get around by structuring differently. For example, you invest in a company, which then buys residential rental investment. Since you have invested in shares, under current rules, the cost of borrowing is your expense, but this will not be allowed.
A suggested approach to deal with interposed entities is to define ‘Residential property land rich.’ It is proposed that when an entity owns over 50% investments into residential properties, then ring fencing of losses would be applicable.
Saurav Wadhwa is the Principal Accountant at IBBZ Accounting Limited, Chartered Accountant and Tax Specialist based in Botany, Auckland. He can be contacted on (09) 2728050; Mobile: 027-5555458; Email: saurav@ibbz.co.nz; Website: www.ibbz.co.nz
