Ringfencing losses another challenge for residential landlords

THE Government campaigned on several policy measures that it considered would make the tax system fairer and improve housing affordability for owneroccupiers by reducing demand for residential properties from speculators and investors.

We have already seen the introduction of limits on the ability of foreigners to buy residential properties and the extension of the brightline rule, which taxes sales of residential land, from two years to five years.

The next measure is the proposed introduction of a loss ring fence for residential rental properties. Under the proposal, owners of residential property will no longer be able to offset losses arising from their residential properties against their other income. So, if you own a residential rental property and the rent is insufficient to cover outgoings on the property, say in a year of significant repairs, you would no longer be able to offset that loss against your salary or business income to reduce your income tax liability.

You will be able to offset the loss against income derived from another residential rental property, or from selling residential land.

This restriction will apply only to residential land. It will not apply to commercial properties, a person’s main home, residential land held as part of a dealing, developing or building business, or where the property has both incomeearning and private use (for example, a holiday home that is rented for part of the year).

IRD acknowledges that avoidance rules will be required to prevent structuring around the proposed ring fence. For example, IRD 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. As with much in the tax world, what sounds like a simple proposal ends up being a complex set of rules once the intricacies of trying to achieve the desired outcome are worked through.

Why does the Government wish to ringfence for residential property losses? They consider that the ability of investors to offset their losses against other income gives them an advantage over owneroccupiers. This advantage arises from property investors having part of the cost of servicing their mortgages subsidised by the reduced tax on their other income sources, helping them to outbid owneroccupiers for properties.

Of course, it could be argued that this ability to offset losses against other income is a subsidy for tenants on their rent, and the removal of ability to offset losses will result in higher rents rather than cheaper houses. Furthermore, this treatment then makes residential rental properties different from commercial rental properties, shares and other types of incomeproducing/ valueappreciating assets.

If one takes account of all the new challenges for residential landlords, including a move towards ‘‘warrants of fitness’’, Health and Safety requirements/ risks, perceived preference against landlords in tenancy disputes, the escalating damage rate such as ‘‘meth’’ houses and simple wilful damage, escalating costs like rates and insurance, the taxing of ‘‘capital gains’’ and now, potentially, loss ringfencing, I consider that there will be an escalating bias against residential rentals versus, say, shares or commercial property, as an investment class for middleclass New Zealand. This will inevitably lead to a further shortage of rental stock and increasing rents in the short term until a new ‘‘equilibrium’’ emerges.

Subject to submissions, the ringfencing rule is intended to begin from April 1, 2019 for most taxpayers, and is something to keep in mind if you are considering investing in residential rental properties, or already own properties and are reviewing rents.

Scott Mason is the managing partner of tax advisory at Crowe Horwath Australasia.