Ring Fencing of Residential Rental Tax Losses

Ring Fencing of residential rental property losses has come into effect from the 2020 income tax year (that's the tax year starting 1 April 2019 for most people).

What does this mean?

If the residential property was running at a loss (expenses are greater than income), then a loss is created.  Depending on how the property was owned this loss would flow back to an individual.

If that individual had paid tax, for example PAYE, then it is quite possible that they'd have paid too much tax after bringing in the rental loss, and a refund of tax would be payable to the individual from the IRD.

From 1 April 2019 the tax losses generated will be recorded in the individuals name and carried forward to future years.  Where a profit is generated from the rental property, these tax losses are then used to offset the profit up until such time as all the losses are utilised.  It's at this point, once the losses are all used up that tax would then be payable by the individual on future profits made.

Why do rental properties run at a loss?

Not all rental properties run at a loss.  The two primary reasons are the level of debt raised to purchase the property versus the rental return. If you have purchased a property entirely with debt and the interest rate on that debt is 5%, but your total rental return is 4% of the purchase price, then that property is going to be running at a loss before you even consider the other costs such as rates, insurances, repairs & maintenance, property management, accounting fees etc. This is commonly referred to as negative gearing.

A property doesn't run at a loss forever, overtime rental returns should increase, yet the debt levels should remain the same or decrease, resulting in income being generated.

What exclusions are there?

Losses incurred from running rental activities listed below are excluded -

  • The family home
  • Commercial premises
  • Where the property is subject to the mixed-use asset rules (bach rules)

How does it work?

The tax positions will be calculated under the existing tax laws associated with residential rental properties, or more specifically "residential land" which includes bare land rented out.

Where a loss is generate from multiple properties you can collate the overall position of all the properties (offsetting profits against the losses in your portfolio).  This will be the default option but you can chose to deal with the profits and losses on a property by property basis.

Can I use the Ring-Fenced losses for anything else?

  • Ring fenced tax losses can be used to offset income from rental properties
  • Taxable income on the sale of any residential land - normally land is not taxable upon sale, however if you are caught by the brightline test as an example (investment property bought and sold within 5 years) then the losses can be used to offset income from.

So in a nutshell, from 1 April 2019, losses from residential rental properties can no longer be transferred to the individual to offset their taxable income, they are now ring-fenced and can only be held and then utilised when the portfolio of properties start making a profit.

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