ACCOUNTANCY WITH BELLINGHAM WALLACE
Accountancy with Graham Lawrence of Bellingham Wallace.
What do the loss ring-fencing rules mean for property investors? With the new rental loss ring-fencing rules taking effect from 1 April 2019, along with the extension of the bright-line test from two to five years announced last year, there is no better time than now for property investors to re-look at their existing property investment portfolio and consider whether the structure of their investments remains appropriate for tax purposes. The loss ring-fencing rules effectively extinguish the longstanding tax advantages that residential property investment supposedly had over other forms of investments by removing the ability for investors to utilise their rental losses to offset against their other income sources, thereby minimising any end-of-year tax due or eliminating tax refunds in many cases. This tax advantage is now available for all other asset classes – clearly the playing field has hardly been levelled. So, what do property investors need to be aware of? What are the tax impacts arising from these new tax rules? Details details details… The loss ring-fencing rules limit a property investor’s deductions for rental expenses to the extent of the rental income derived from the residential property for an income year. Any excess losses (i.e. where rental expenses exceed rental income for an income year) can only be offset against future income received from residential property or can only be used on the sale of the property that is fully taxed. The end result is that investors can no longer use their annual tax refund to fund their property investment. Furthermore, these rules not only apply to residential properties in New Zealand but also to overseas properties, so there is no escape for property investors! Residential land-rich entities – what are they? The ring-fencing rules also apply if one borrowed money to invest in a “residential land-rich entity”, for example, borrowings for acquiring shares in a company. These are interposed entities that may potentially be used to separate a loan (and interest deductions) from the residential rental property, so the interest deductions are not subject to ring-fencing. A company, partnership, a look-through company or a trust can be a “residential land-rich entity’ if more than half of their assets by value are residential properties. Special ring-fencing rules are in place to deal with the interposing of such entities. Exceptions to the rules Fortunately, there are always some carve-outs in tax law: The key carve-outs are: • One’s main home. • Properties held on revenue account (a residential property would be captured if its disposal would give rise to taxable income). • Properties held by non-close companies (being a company that has more than five natural unrelated persons with a combine interest of more than 50%). • Mixed-use assets (e.g. holiday home and bach which are available for both personal and income-earning use). • Properties provided by employers for employees’ accommodation. • Properties held by Government enterprises.
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Issue 103 - October 2019 www.channelmag.co.nz
Graham Lawrence.
Opportunities for property investors Property investors can always make lemonade as long as “the number works”. On the flip side of these rental ring-fencing rules, investors should seek other opportunities including: 1. Switching to commercial property investment For those investors with stronger balance sheets, we might expect to see a switch from investing in residential properties to commercial properties as the new ring-fencing rules do not apply to commercial property investments. 2. Adding another residential rental property to your property portfolio Investors may consider adding on an additional residential property to take advantage of the ability to offset rental losses from one residential property against rental profit of another under the “portfolio basis” approach. This is provided that the investor has not elected to offset rental losses on a property-byproperty basis. 3. Paying down your mortgage and increasing the rent For those risk-averse or highly-geared property investors, you should aim at moving your rental properties to a positive-geared position where possible, by paying down the mortgages on your rental properties to reduce rental losses and eliminate any unused losses being ring-fenced. Other measures such as increasing rents can also be a practical and simple option to help with funding the property investment in the long term. 4. Widen asset base and include other forms of investments Entities being treated as “residential-land rich entities” for the purpose of these rules, may have a narrow opportunity to work around these rules so that they do not fall under this specific definition.
Investors may consider adding on an additional residential property to take advantage of the ability to offset rental losses… In closing… The above provides property investors with a general view only. Any major investment decisions must be exercised with care and balanced out with commercial reality as well as the overall financial position of the investor. Given the changes to property tax law in the last year it may be time to get a health check on your tax position. Contact your Bellingham Wallace advisor today to discuss this further. By Graham Lawrence (Director) and Jenny Ni (Tax Consultant) Phone: 09 309 7851 Email: grahaml@bellinghamwallace.co.nz Visit: www.bellinghamwallace.co.nz