IRD releases 'ring-fencing' paper; Revenue Minister encourages feedback on proposal to ensure investors can't offset losses on property investments against other income

By David Hargreaves

The Government’s progressing its plans to ‘ring-fence’ investors’ losses on residential properties as it continues its push against property speculation.

An Issues Paper has been released by the Inland Revenue Department on the proposal to change the rules in what the Government says is “an effort to level the playing field between speculators and investors – and home buyers”.

IRD is proposing that the new rules will apply from the 2019-20 tax year and will mean that investors will no longer be able to offset losses on property investments against their other income. It’s not definite yet that the new rules will be applied in entirety from April 1 next year as the IRD says it would be possible to phase the rules in over a two or three year period (by gradually reducing the amount of losses that can be applied against other income). However, the IRD appears to favour applying the rules in entirety from next year.

Revenue Minister Stuart Nash, in “encouraging feedback” on the proposed changes, says the “persistent tax losses” that many property investors declare on their investments indicate that they rely on capital gains to make a profit..

The changes will “make the tax system fairer” Nash says.

This move had been widely signalled by the Government and follows on from changes to the bright-line test, extending the period at which capital gains on sale of investment properties are taxable from two to five years.

“In conjunction with the recently announced extension to the bright-line test, ring-fencing losses from rental properties would make property speculation less attractive and level the playing field between property investors and home buyers. The time is right to test the detail of this proposal with investors and other stakeholders,” Nash says.

What the IRD is suggesting:

As proposed, the rules would not apply to a “main home”, or  a property that is subject to the mixed-use assets rules (for example, a bach that is sometimes used privately and sometimes rented out), or land that is on revenue account because it is held in a land-related business.

IRD is suggesting that the ring-fencing should apply on a “portfolio basis”, which means that investors would be able to offset losses from one rental property against rental income from other properties – calculating their overall profit or loss across their portfolio.

Also under the suggested changes, a person’s ring-fenced residential rental or other losses from one year could be offset against their residential rental income from future years (from any property) and their taxable income on the sale of any residential land.

The IRD’s also suggesting “special rules” to ensure that trust, company, partnership, or ‘look-through’ companies can’t be used to get around the ring-fencing rules.

It is proposed that such entities will be regarded as “residential property land-rich” if over 50% of the assets are residential properties within the scope of the ring-fencing rules, and/or shares or interests in other residential property land-rich entities.

Where that is the case, IRD suggests that any interest a person incurs on money they borrow to acquire an interest in the entity (for example, shares, securities, a partnership interest, or an interest in the trust estate) would be treated as rental property loan interest.

“The rules could then ensure that the interest deduction is only allocated to the income year in question to the extent it did not exceed the distributions from the entity (deemed rental property income), any other residential rental income, and residential land sale income. Any excess of interest over distributions, rental income, and land sale income would be carried forward and treated as “rental property loan interest” for the next income year,” IRD says. 

This is the statement from the Government:

Revenue Minister Stuart Nash is encouraging feedback on a proposal to change the rules around ring-fencing losses on residential properties.

An Issues Paper has been released by the Inland Revenue Department that proposes ring-fencing losses in an effort to level the playing field between speculators and investors, and home buyers.

“Changes would make the tax system fairer by ensuring that investors could not offset their losses on some property investments against their other income,” Mr Nash says.

“At the moment, tax is applied on a person’s net income, which means if a property investor makes rental losses those losses reduce their overall income, and therefore their  tax liability.

“The persistent tax losses that many property investors declare on their investments indicate that they rely on capital gains to make a profit.

“In conjunction with the recently announced extension to the bright-line test, ring-fencing losses from rental properties would make property speculation less attractive and level the playing field between property investors and home buyers. The time is right to test the detail of this proposal with investors and other stakeholders.

Mr Nash says ring-fencing losses would be a useful tool to dampen property speculation. “This measure would not preclude any solutions the Tax Working Group may come up with in relation to housing”.

“I encourage the public to make submissions to Inland Revenue before the deadline of 11 May 2018,” Mr Nash said. For more information, including how to make a submission, see http://taxpolicy.ird.govt.nz.