The release of an official's issues - paper entitled "Ring-fencing rental losses" was issued in march 2018. and introduced into Parliament on 5 December 2018 as a part of the taxation (Annual Rates for 2019-20, GST Offshore Supplier Registration, and remedial Matters) Bill. According to this proposal, speculators and investors will no longer be able to offset tax losses from the residential properties against their other income but can be used in future years to reduce the tax when the properties make profits or the sale of land.
Property subject to the rules (ss DB 18 AC to DB 18 AK)
The provisions of "Ring-fencing rental losses" will apply to "residential rental property", which is defined as "residential land'. However, the following are excluded from "residential rental property".
Land taxable on sale
The proposed rules will not apply if the land is identified to IR as being taxable on sale. This would include land held in dealing, development, subdivision, and building businesses, and land that was bought with the intention of resale.
the exclusion for land that will be taxable on sale will be available if either:
Portfolio basis by default with property-by-property application by election
The proposed default position is that the loss ring-fencing rules will apply on a portfolio basis, which means the investors are able to offset deductions for one rental property against income from other rental properties.
Use of ring-fenced deductions
Portfolio basis
if the portfolio basis is used, ring-fenced residential property deductions will be able to be offset against:
property-by-property basis
If the property-by -property basis is used, ring-fenced deductions relating to the property will be able to be offset against:
Unused deductions
Generally, any remaining unused deductions will continue to be ring-fenced and carried forward to be used against any future residential rental income or income from other residential land sales
However, it is proposed that ring-fenced deductions will be released in certain situations.
Transfer between companies in wholly-owned group
Ring-fenced deductions are allowed to be transferred between companies in a wholly-owned group according to proposed s DB 18AI. And any remaining deductions will be carried forward and will remain ring-fenced. The transferred deductions will remain ring-fenced until offset against residential rental income or residential land sale income.
Interposed entities -residential land-rich entities
The interposed entity rules will apply for interest on borrowings to acquire an interest in an entity if, for a particular income year, the entity is a "residential land -rich entity" - which will be where over 50% of the entity's assets are residential properties.
where the land - rich threshold is met, part or all of the interest on the borrowings will be treated as residential rental property expenditure, and deductions will be ring-fenced.
The proposed new rules are intended to apply from 1 April 2019 for the 19/20 and later income years. They will not apply to a deduction a person is allowed for a prior income year.
Property subject to the rules (ss DB 18 AC to DB 18 AK)
The provisions of "Ring-fencing rental losses" will apply to "residential rental property", which is defined as "residential land'. However, the following are excluded from "residential rental property".
- a person's main home
- land that is subject to the mixed-used assets rules
- land that is owned by a widely-held company
- land that is identified to Inland Revenue (IR) as being taxable on sale (see below), and
- accommodation provided to employees or other workers where it is necessary to provide the accommodation due to the nature or remoteness of the business carried on.
Land taxable on sale
The proposed rules will not apply if the land is identified to IR as being taxable on sale. This would include land held in dealing, development, subdivision, and building businesses, and land that was bought with the intention of resale.
the exclusion for land that will be taxable on sale will be available if either:
- the taxpayer is notifying the Commissioner of their rental income and expenditure for that property on a property-by-property basis, or
- they are notifying the Commissioner of their rental income and expenditure on a portfolio basis and all of the properties within the portfolio are on revenue account
Portfolio basis by default with property-by-property application by election
The proposed default position is that the loss ring-fencing rules will apply on a portfolio basis, which means the investors are able to offset deductions for one rental property against income from other rental properties.
Use of ring-fenced deductions
Portfolio basis
if the portfolio basis is used, ring-fenced residential property deductions will be able to be offset against:
- residential rental income from future years (from any property)
- income on the taxable sale of any residential land, to the extent of reducing the taxable gain on the sale to nil.
property-by-property basis
If the property-by -property basis is used, ring-fenced deductions relating to the property will be able to be offset against:
- residential rental income from future years (from that property)
- income on the taxable sale of that property, to the extent of reducing the taxable gain on the sale to nil.
Unused deductions
Generally, any remaining unused deductions will continue to be ring-fenced and carried forward to be used against any future residential rental income or income from other residential land sales
However, it is proposed that ring-fenced deductions will be released in certain situations.
Transfer between companies in wholly-owned group
Ring-fenced deductions are allowed to be transferred between companies in a wholly-owned group according to proposed s DB 18AI. And any remaining deductions will be carried forward and will remain ring-fenced. The transferred deductions will remain ring-fenced until offset against residential rental income or residential land sale income.
Interposed entities -residential land-rich entities
The interposed entity rules will apply for interest on borrowings to acquire an interest in an entity if, for a particular income year, the entity is a "residential land -rich entity" - which will be where over 50% of the entity's assets are residential properties.
where the land - rich threshold is met, part or all of the interest on the borrowings will be treated as residential rental property expenditure, and deductions will be ring-fenced.
The proposed new rules are intended to apply from 1 April 2019 for the 19/20 and later income years. They will not apply to a deduction a person is allowed for a prior income year.
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