Introduction of the ring fencing rules from 1 April 2019 - Quick Update
Updated: Oct 1, 2019
The act introduced a new subpart EL into the income tax act that limits the “Allocation of deductions for excess residential land expenditure”. In simple terms, it means that any residential rental loss can no longer be offset against other forms of income such as your personal employment income. So, instead of getting a personal tax refund, the rental loss would be carried forward indefinitely to be offset against any future rental profit.
Example In year 1, your rental property makes a loss of $10,000. In year 2, rents rise a bit and the interest rate on the rental loan decreases, so your rental property makes a loss of $5,000. In year 3, you pay off some of the rental loans so your rental property makes a profit of $3,000 in that year and in each subsequent year. Here’s how the figures would look:
Rental Profit/(Loss) Accumulated Loss Tax to Pay if taxed at 33%
Year 1 ($10,000) ($10,000)
Year 2 ($5,000) ($15,000)
Year 3 $3,000 ($12,000)
Year 4 $3,000 ($9,000)
Year 5 $3,000 ($6,000)
Year 6 $3,000 ($3,000)
Year 7 $3,000 - $1,000
Year 8 $3,000 - $1,000
Year 9 $3,000 - $1,000
Year 10 $3,000 - $1,000
What Properties does this apply to?
The ring-fencing rules only apply to residential land. This is land that has a dwelling on it, will have a dwelling on it or could be used to have a dwelling on it. However, it does exclude farmland and land used predominantly as business premises.
A dwelling is any place used predominantly as a place of residence. However, it does exclude hostels & boardinghouses but does include serviced apartments.
In summary, the ring-fencing rules will apply to:
any typical residential investment property situated in NZ
any typical residential investment property situated overseas
The ring-fencing rules will not apply to:
any commercial investment property
a ‘granny flat’ on your personal home if more than 50% of the property is used for most of the year as your main home Rental Property Guide Updated September 2019 Page 6 of 43
residential properties that are being held as property trades to which income tax will apply Mixed used assets such as a residential property if that property was rented out, used privately and not used for at least 62 days in that year (ie some properties used for a bach or short term rental)
Residential properties that are widely held (ie residential property investment entities listed on the NZ stock exchange)
Portfolio Basis or Property-by-Property?
The ring-fencing rules can be applied on a portfolio basis or on a property-by-property basis. There seems to be little benefit in most situations in using a property by-property basis approach so the default position will be the portfolio basis whereby you would offset any income from profit-making rental properties against any loss from any loss-making rental properties. What Properties are in your Portfolio? Each property owned under a separate legal entity will form a portfolio. For the purpose the income tax rules, a property owned by a look through company is deemed to be personally owned. So, an individual’s property portfolio will include personally owned properties as well as properties owned under a partnership or look-through company. A trust’s property portfolio will only include properties that the trust owns. A trust cannot distribute rental income to an individual in order to offset that rental income against any individual rental loss as they are still two separate property portfolios.