OPINION: Ring-fencing tax losses from residential property in 2019

Former Deputy Prime Minister and Minister of Finance Sir Michael Cullen leads The Tax Working Group.

The New Year promises to be another significant one in relation to tax matters.

The Final Report from the Tax Working Group will no doubt provide plenty of talking points when it is issued in early 2019.

However, there is also plenty happening outside the important tax policy issues being considered in that forum.

A Bill was recently introduced to provide for the ring-fencing of tax losses in relation to residential property.

It is proposed that, from the income year beginning April 2019, investors will no longer be able to offset expenditure in relation to loss-making residential property investments with income from other sources.

If residential property expenditure exceeds income from residential property, it is "ring-fenced" and must be carried forward to future income years.

The new rule will apply to "residential land" using the same definition as that which applies for the bright-line test.

There are, however, certain exceptions including land that the IRD has been notified will be taxable on disposal and employee accommodation provided due to the nature or remoteness of an employer's business.

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It will also seemingly not apply to a scenario where only part of a person's main home is being rented to a third party provided the property is used predominantly as the person's main home.

The Bill does not contain any guidance for determining whether expenditure relates to residential property.

There may therefore be some difficulty for entities with a portfolio of assets to determine whether a given expense "relates" to its residential property investments.

Interest, for example, could potentially relate to debt secured for several real estate or other assets and fees for financial advice and accounting or legal services could relate to various matters.

Presumably some sort of apportionment will be required in these circumstances.

A specific rule has been included to deal with the interposition of a legal entity to circumvent the rules.

The rules still apply, for example, where a taxpayer borrows in one entity and then uses those funds to subscribe for shares in a company that in turn uses the funds to buy residential property.

However, the targeted rule applies only for a "residential land-rich entity" which requires over 50 per cent of the entity's assets by value to be residential land.

It may therefore be that borrowing to capitalise an entity with a more diversified portfolio of assets will be outside the scope of the new rules.

Happy holidays to all.

* Greg Neill is a tax partner at Crowe Horwath - Hawke's Bay.
This information is general in nature and readers should seek specialist advice before making financial decisions.