Soon landlords won't be able to offset their residential rental losses against other income, as the Government introduces ring-fencing legislation.
The legislation is a move to reduce the Government's perceived unfairness between property investors and owner-occupiers.
The Government expects the rules to improve a first-home buyer's ability to compete with investors, improve housing affordability, and increase tax revenue by about $190 million per year.
But it means residential property investors will not be able to offset rental losses against other income. And renters may find their rents increase because fewer rental properties will be available.
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Other possible consequences include:
● If housing affordability improves then existing property owners may suffer from lower property values.
● If rents do go up this will increase the cost for those who provide rent subsidies - the Government itself.
In the coversheet to the Regulatory Impact Assessment issued by Treasury and the IRD which accompanied the legislation, the IRD Quality Assurance reviewer stated:
"... it is not possible to be confident that the stated objective is being met in the best way and with the least unintended consequences."
In my opinion, if there is no certainty the legislation will be successful with its stated purpose, it is irresponsible to introduce and pass this legislation without having a clear expectation that it will be successful.
Ring-fencing rules won't be phased in. The rules will apply from the 2019-2020 income year, so for most taxpayers, this will be from April 1 2019.
The new rules are unfair to investors who have already bought residential rental property based on the current tax rules. The fairest way would be to apply the ring-fencing rules to new purchases of residential property, as past purchases will have little or no impact on current first-home buyers or housing affordability.
Existing residential property investors are now trapped. If they decide to sell their property because their rental losses are no longer available to them, they could suffer the tax consequences of the bright-line test which taxes gains on residential property sold within two years of purchase (or five years if the residential land was bought on or after March 29, 2018).
The residential land subject to the ring-fencing rules is essentially the same residential land caught under the bright-line test with some limited exceptions:
● Land subject to the main home exclusion
● Holiday homes subject to the mixed-use asset rules where expenditure is already apportioned
● Land elected to be taxable on sale
● Land owned in widely held companies
● Certain employee accommodation
Overseas residential land is also included in the ring-fencing rules, despite having no effect on New Zealand first-home buyers or New Zealand's housing affordability.
If more than one rental property is owned then the properties will be treated as a portfolio unless the taxpayer elects for each one to be treated separately.
Rental losses will be claimable to the extent that subsequent rental profits are made or if taxable income is made on sale of the residential land. Otherwise the rental losses will continue to be carried forward, and potentially could never be claimed.
With the ring-fencing rules, tax compliance costs will also rise as it will be harder for investors to prepare their own tax returns. The new rules will be another reason for residential property owners to consider alternative uses such as Airbnb.
Residential rental property owners need to act soon. Now is the time to consider incurring any tax-deductible expenditure such as repairs, to ensure they do obtain a tax deduction against other income before the new rules apply. It will be interesting to see what the effect of the rules will be. With so many changes now affecting residential property, isolating any one effect may be difficult.
- Leicester Gouwland is a director of financial services firm Crowe Horwath.
