Rental loss law change could lead to surprises, by Dale Adamson
Ring fencing of losses for residential rental properties, aimed at ending landlord’s ability to offset rental losses against other income, was enacted into law in June 2019. The changes applied retrospectively from the start of the 2019/20 income year,1 April 2019 for most taxpayers, but are only now having effect as we process 2020 returns. The result is that many taxpayers who historically received tax refunds are no longer entitled to them and, depending on their actual income composition, may have tax to pay.
The rules apply to “residential land” as defined by the Bright-Line test and exclude the taxpayer’s main home, property held on revenue account (land dealers, developers, builders or property purchased with intention of resale), property held by non-close companies, property already subject to the special mixed-use asset rules and property provided as employee accommodation (subject to special rules). Note that, for a NZ tax resident, the rules also apply to residential rentals outside NZ.
Residential property deductions claimed cannot exceed the amount of income earnt from the property for the year. Any excess deductions must be carried forward from year to year until they can be used.
By default, the rules apply on a portfolio basis, meaning the excess deductions from one residential property can be offset against income from other residential properties – essentially calculating overall profit or loss across the portfolio.
However, a taxpayer can elect for the rules to apply to some residential properties on a property-by-property basis and have others in a portfolio. Electing to apply the rules on a property-by-property basis means any excess deductions generally stay with a specific residential property.
There are advantages and disadvantages with either option that need to be considered as they affect future and current claims. Once an option is selected for a specific property, it is locked in.
If and when excess deductions can be claimed against other residential rentals or released to be offset against other income, depends on the option used and the tax nature of any property sale.
If properties are held in a close company, a significant change in shareholding can result in the forfeiture of losses. With look through companies, the company’s option choice flows through to the shareholders. Whereas the partners in a partnership can choose their own treatment of partnership excess deductions, so this may vary between partners.
The ring-fencing rules mean taxpayers will need to track losses and profits from their residential properties to ensure any deductions are only being claimed as allowed. The rules are complicated, so we recommend that you work with your tax advisor to evaluate your rental portfolio performance and ensure you are not disadvantaged - or at the very least, not surprised.