Following the IRD White Paper from the Policy Team at IRD which was issued in March 2018 legislation is being enacted that will see ‘ring-fencing’ of losses from rental properties. This will mean that investors can no longer use those rental losses to reduce their “other” taxable income such as wages, salaries, and business income. Unfortunately, this will put a stop to those tax refunds that have assisted investors with their cash-flow requirements.
The impact of the legislation is that the rental losses won’t be forfeited but will simply be carried forward, so they can be offset against future rental profits, or against taxable revenue earned from the sales of property that will be captured under the Brightline 5 year sale rule. Arguably, this is just a timing issue, but for some property investors, cash flow is going to be significantly impacted.
Why take away these tax refunds?
The IRD has been saying for years that where an investor suffers some sort of real economic cost, i.e. it hits their back pocket, then, to that extent, they should be entitled to deduct that for tax purposes. However, with rental property losses these days most investors are borrowing to the maximum (i.e. 100% gearing) and they are suffering losses when covering the additional interest costs associated with such borrowing. The situation would economically be different if the investor had simply put equity into a property purchase using their own cash reserves, rather than borrowing the full 100% of the investment property value. Hence the Government’s desire to limit the offsetting of the negative-geared losses.
One small benefit from owning multiple properties
Most investment decisions are not driven off the back of tax savings. Nevertheless, these legislative changes will mean that property investors will need to fund losses themselves until the properties start turning a profit. As a slight saving, however, the IRD’s position is that under a ‘portfolio’ basis investors will be able to offset losses from one rental property against rental profits from other properties and thereby calculate the overall profit or loss across all of their portfolios. Therefore, at least not all investors are going to have to wait until a particular rental property makes a profit before they can offset losses.
Needless to say, the legislation doesn’t apply to peoples’ main homes, properties owned as part of a land-related business (they are taxable on sale anyway) or any properties which are subject to the mixed-use asset rules, like a person’s bach which is used privately and rented out occasionally.
What can you do if you are a simple property investor trying to get ahead with your property investments? Well here are some answers to ponder, and get in touch with us about:
- Is your property debt structured correctly in the first place, i.e. are you properly maximising tax deductions on interest in the correct entities?
- Have you reviewed your tenancy agreements to see what changes you can make to cover the loss of tax refunds with tenant-funded charges?
- If you are in business generally, can you look at how your business structure may be able to take the ring-fencing of property losses headache away?
- Can you look to invest in positively geared properties to offset those that are negatively geared?
At Prudentia Law, we can help you with advice and guidance in these areas. Please give us a call on 09 912 1985.