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Wednesday, March 3, 2021
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Big changes likely if ring-fencing losses becomes law

The Labour government’s ongoing attempts to create a fairer tax system, deter speculative investors and close the housing affordability gap, now include the proposed introduction of a loss ring fence from the Inland Revenue Department (IRD).

With the proposed legislation potentially affecting a swath of well-intentioned domestic investors, it is important to be aware of what this proposed change is, what its purpose is and how to best navigate any forthcoming issues.

What, why and who

Ring-fencing, in essence, is the introduction of restrictions around offsetting losses from inter-trade income.

With a ring-fence, you will only be able to offset losses on income within the same trade (a portfolio basis approach).

If the proposal becomes law, it will mean property investors will no longer be able to claim losses against income such as salary, wages or other business income.

The stated reason for the proposed legislation is to level the housing market playing field, offset the tax advantages of owning or inventing in rentals and make housing more affordable for those entering the property ladder.

The proposed legislation is also expected to raise $325 million over five years.

This proposed change will not affect everyone. It is aimed at the residential housing market, and commercial property will be exempt.

But if you (or your business entity) are currently invested in the housing market (including bare land), other than short-term lodging (bnb, hostel), you will potentially be affected.

There are exceptions for “mixed use holiday homes” and the “main home” (i.e. boarders & lodgers), which already have restrictions including ring-fencing rules in place.

Potential consequences

According to the government’s stated intentions, these changes will aim to release some of the steam in the housing market pressure cooker and renew the opportunity for younger New Zealanders to have a future in the housing market. The proposal follows on from restrictions on foreign investors acquiring land in New Zealand.

However, the consequences will not necessarily be all positive. The proposed legislation will make it considerable harder for those looking to rent.

Without the ability to offset losses, the difference will inevitably be passed onto the tenant in the form of rent increases or deferred maintenance, in order to spread the cost.

Similarly, as the proposed legislation does not apply to commercial and bnb style operations, landlords may be more inclined to move away from providing long-term lodging and into the short-term accommodation sector.

Losses are proposed to be 50 percent ring fenced from April 1, 2019, and 100 percent by the following year.

There are some opportunities to reorganise debt, or consider advancing your R&M schedule on your property, but the old ways of restructuring ownership to effect a refund will have truly passed if the legislation becomes law.

The result of the legislation is expected to lead to fewer refunds of tax (or more tax payable) than before, and higher provisional tax obligations as the residential property losses will no longer offset personal wages, or other business income.

The legislation is still to be passed. But if it does, all indications are that ring-fencing of residential property losses is a certain outcome.

It is important to understand what exactly the proposed legislation will mean for you, how to navigate the prospective changes and how to best prepare for any change.

We await the next steps from the government. However, if the extension of the Bright line test is anything to go by, it may come into law with little time to plan if you haven’t already done so.

Alex Pearce
Alex Pearce is a Senior Manager at BDO Rotorua, specialising in tax (domestic & international) and accounting information systems. You can contact the team at BDO Rotorua on 07 347 9087

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