Crowe Horwath: Ring-fence property tax loss

Ring-fencing laws will impact tax for property owners. Photo / 123RF

A Bill was recently introduced to Parliament, seeking to codify 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 on residential property 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. Exceptions via the IRD do apply, including on land and employee accommodation provided due to the nature or remoteness of an employer's business.

It will also seemingly not apply to scenarios where part of a main residence is being rented to a third party, provided the property is used predominantly as the main home.

The bill lacks real guidance on determining how expenditure will be codified by the IRD.

Entities with a diversified portfolio of assets must determine whether a given expense "relates" to residential property. Interest could potentially relate to debt secured for several other assets. Fees for financial advice, accounting or legal services could relate to residential property matters also. Presumably, some sort of apportionment will need to be outlined.

There has been a focused effort to address attempts to circumvent the new rules. For example, a taxpayer will be unable to borrow funds and funnel them through a series of entities to buy residential property to limit tax liability.

However, the targeted rule applies to only "residential land-rich entities" meaning the portfolio is 50 per cent residential property. It's possible that borrowing to provide capital to an entity as a method of funding diversification will be outside the new scope.

So what affect could this have on you?

If you have historically offset those residential rental losses, it would have reduced tax liability on other income. A range of investors would likely have forward planned their repayment power based on this offset being in place.

Under the new rules, refunds from residential rental losses disappear, meaning more tax to pay if other income was reduced by those losses — you will need to carefully plan for the tax year 2020 and beyond.

This information is general in nature and readers should seek specialist advice before making financial decisions.