The exceptionally dry-sounding Taxation (Annual Rates for 2019-20, GST Offshore Supplier Registration, and Remedial Matters) Bill has been introduced to Parliament.
We expect it to be passed in its current form, without any significant adjustments.
What’s changing for loss ring-fencing
We’ll no longer be able to offset losses from residential properties against other income. Currently, a loss on a rental property of (say) $10,000 could be offset against PAYE or other business income, generating a tax refund of $3,300 for most people.
The losses usually arise from the property being negatively geared, and in some cases from doing significant repairs (like repainting) on a property.
Under the new rules, the losses won’t be offset. This means you’ll only get the tax benefit from the rental property when the property turns a profit.
The new rules apply from 1 April 2019 (for the 2020 Financial Year). So if you’re used to receiving a refund each year, the final refund will be for the March 2019 year.
TIP: Make sure you keep reading to learn how maximise your final loss.
What’s not changing for loss ring-fencing
If your property runs at a profit then there is no impact on you.
Also, you’re still able to claim a tax deduction for the same things you could previously. So you can still claim depreciation, interest on lending, repairs, rates, insurance etc. We just can’t offset any losses resulting from the deductions.
The new rules don’t apply to commercial property.
Why the new rules for loss ring-fencing were introduced
The new rules follow through on an election policy of the Government during 2016 — albeit in a different form.
When announced, it was designed to target “large-scale speculators who own multiple rentals and use losses on new acquisitions to continually reduce their tax”.
It was also going to be phased in over a five-year period to give people an opportunity to respond to the new rules.
The rules we’ve now got have no phase in period (applying in full force from 1 April 2019) and make no distinction between large-scale speculators, and “Mum and Dad” investors with one property.
Our two cents on the new rules
Whether you like the new Government policy or not, the new rules for loss ring-fencing are coming. Putting the policy to one side, we don’t have any particular issues with the rules except for the unintended consequences.
These unintended consequences could include:
- Poorer quality rental properties — some investors will no longer be able to afford the repairs necessary on their properties, meaning the standard of rental stock will drop. This could be balanced by the new Healthy Homes initiatives.
- Landlords exiting the market — some investors will exit the market. This creates increased demand for rentals (potentially increasing rents), and may hold general housing prices back. This makes the cost of a mortgage relatively more appealing compared to paying rent.
- Reduced retirement savings — financial literacy is appalling in New Zealand. For many people, buying a rental property was their only method of saving for their retirement. The new rules may turn people away from property, meaning a reduction in saving.
- Hard to get on the investor ladder — if you already own multiple rental properties, then the chances are that you are in a cashflow positive position and the new rules won’t impact you. That said, you probably enjoyed the benefits of negative gearing initially, which helped you build your portfolio. New investors won’t have this same advantage.
- Increased demand for commercial property — the new rules only apply to residential property (likewise, commercial properties are outside the Brightline rules). This may create increased demand in the commercial sector.
As we said though, like it or not, the new rules are coming.
How to respond
How you should respond to the new rules will be entirely determined by your specific situation.
For example, a business owner might look to restructure their bank lending to shift debt onto their business (rather than having it on a rental property). This could mitigate the impact of the new rules.
Alternatively, a salary and wage earner might look to buy an additional property that is cashflow positive (high yield, low capital growth). The profit from the new property is able to be offset against the loss from the existing property. Again, this mitigates the impact of the new rules.
To discuss the options for your particular situation (whether it is covered above or completely different) please contact us.
Maximise your final loss
Any losses from the 2019 Financial Year can be offset, while those from the 2020 Financial Year onward can’t be.
So, the incentive is to maximise your final year loss. If you have any delayed repairs that you’ve been putting off then now is the time do to them.
The re-roofing or re-painting can be claimed and offset against other income if the expenses is incurred before 31 March 2019.
Your tax payments
If you’re currently a provisional tax payer, keep making your regular payments for the time being.
The first tax payments impacted by these new rules are:
- August 2019
- January 2020
- May 2020
While they appear a long way off, time passes quickly. You should start understanding the impact of the rules today, so you can adjust rent (where possible) and change your budgeting to put additional tax money aside.
Previously, most investors have owned their rentals in either their personal name or in a Look Through Company (LTC). Moving forward, we expect this structure to become outdated.
We expect most investors to either hold their properties in their personal name, or in a trust structure (where asset protection is appropriate).
To find out if a trust might be appropriate for you, you can read more here.
The main issue with changing your structure now to respond to the new rules is the Bright-line Test. That means you’ll (effectively) pay Capital Gains Tax if you sell the property within five years. So, if you’re restructuring your holdings to mitigate the impact of the new rules then proceed with caution.
This is (obviously) very general advice. It’s not intended for you to rely on in any way. If you need specific advice, which you can rely on, then please get in touch with us.