Ring-fencing Rental Losses

Labour’s pre-election manifesto proposed to increase the fairness of the tax system and improve housing affordability. In the six months since then Labour-led coalition entered Parliament, we have started to see some changes filtering through. As part of the proposals aimed at house prices, Inland Revenue has recently released an Issues Paper proposing to ring-fence rental losses, with draft legislation likely to follow once Inland Revenue has considered public responses. So how would the rules work? People derive income from multiple sources, such as salary/wages, business income, interest, dividends and rental income. It is a fundamental feature of NZ’s tax system that a person is taxed on their total income from all sources, whether a profit or loss.

This aggregation allows losses incurred from rental properties to be offset against other income, reducing a taxpayer’s total income and corresponding tax liability. This Government’s concern is that this mechanism allows property investors to take on high levels of debt to finance their property investments, giving rise to tax losses, which they believe is subsidising the rental portfolio through a reduced tax liability.

The proposed ring-fencing rules contained within the Issues Paper will prevent rental losses from being offset against other income. Instead, rental losses will be ‘ring- fenced’ and offset against future rental income, or any tax incurred on the future sale of the property.

Labour originally indicated losses might be ringfenced by individual property. Thankfully, the proposed ‘portfolio approach’ is more logical, enabling investors to pool their profits and losses from all residential properties, including overseas properties. If enacted, the rules will apply to all rental properties irrespective of how they are held, i.e. the rules will apply to individuals, companies and trusts. The proposed rules also use the existing definition of ‘residential land’. Thus, the rules will not apply to commercial property or property subject to the mixed-use asset rules.

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