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Legislation has now been passed restricting the expenses claimed against residential rental property income from 1 April 2019.  What this means is that for the 2020 income tax year onwards you are no longer able to offset your residential rental property losses against your other income, they are instead carried forward to future years to offset future residential rental property income.

 

Background

The New Zealand Government considered that it was an uneven playing field allowing investors in residential rental properties to be able to deduct expenses in excess of their income against their regular income as they were then able to use the tax saved to offset their mortgage, whereas home buyers are unable to do this.  It was noted that in many cases those buying residential rental properties were doing so with the intention of making capital gains in the long term rather than rental income gains in the short term.  This is different to commercial property owners who are generally looking to generate income on an ongoing basis rather than relying on capital gains in the future. 

The new residential ring-fencing rules are designed to make the tax system fairer, as well as improving housing affordability for owner-occupiers. 

 

So what does this all mean for you

If you own residential rental properties or are looking to invest in residential rental properties, you will only be able to deduct expenses from those properties up to the level of the residential rental income received in that year.  If you end up with more expenses than income, then those expenses are not deductible in that year but can be carried forward to a future year when the property is profitable. 

Here is an example:

Alex owns a rental property in Auckland.  Their annual income is $23,400 and their expenses change from year to year dependent on maintenance work etc.  Their situation could be as follows:

 

2020

2021

2022

Income

23,400

23,400

23400

Expenses

(25,000)

(27,000)

15000

Ring Fenced Losses from Prior Years

0

(1,600)

(5,200)

Net Income

(1,600)

(5,200)

3,200

Ring Fenced Expenses Carried Forward

1,600

5,200

0

Taxable Income

$0

$0

$3,200

 

There are options on how the income and expenses are treated if you own multiple rental properties.  The income and expenses can be treated on a property by property basis (meaning if one property makes a loss, this is not offset against the income of another property that makes a profit) or on a portfolio basis (the expenses from all properties are offset against the income from all properties) or a combination of the two.  There are different situations where each of these methods would be appropriate. 

There are also some situations where the losses will become available to offset your other income when a property is sold, such as if you sell within the 5 year bright-line period. 

If your properties are owned in an LTC the rules are the same but rather than the ring-fenced deductions staying in the company, they are passed out to the shareholders based on their shareholding.  If the shareholder holds rental properties in their own name, they can offset the LTC deductions against their other rental properties, otherwise the excess deductions are carried forward to a future year. 

 

What you should do now:

One of the main things you will need to consider from a tax perspective is whether you are intending on selling any of your rental properties within the bright-line 5 year period.  This may change what method we use to calculate your ring-fenced deductions. 

You may also like to plan for maintenance to be carried out on your properties on a regular basis rather than waiting until tenants move out or until you intend to sell. 

If you rely on the reduction in your tax liability to be able to pay the mortgage on your rental property, you may like to contact your mortgage advisor to discuss your options. 

 

The rules around ring-fencing of residential rental property deductions can be complex.  If you have any questions about your specific situation, please do not hesitate to be in touch.