When will ring-fencing of rental losses apply from?

The Taxation (Annual Rates for 2019-20, GST Offshore Supplier Registration, and Remedial Matters) Bill, introduced 5 December and currently open for submissions, has a proposed application date which will impact tax losses produced from the 2019-2020 income year, which for most taxpayers with a balance date of 31 March will therefore apply from 1 April 2019.

What does ring-fencing of rental losses mean?

Under current tax legislation, tax is applied on a person’s net income, meaning that there is generally (with exceptions) no restriction on losses from one source reducing income from other sources.  The proposed Bill would result in ring-fencing applying in full from the outset of the proposed application date to tax losses produced by residential rental property held by speculators and investors.  This means that speculators and investors will no longer be able to offset tax losses from their residential properties against their other income (ie. Salary, wages, business income etc.) to reduce their income tax liability.  Tax losses accumulated prior to application date are not ring-fenced however.

What type of properties will be captured?

Residential rental property referred to in the proposal specifically refers to land with a dwelling on it that is occupied residentially, or bare land that could have a residential dwelling built on it.  Serviced apartments are included as residential rental property, as are overseas rental properties.  The proposed new rules would not apply to a person’s main home, a property that is subject to the mixed-use assets rules (eg. A bach that is sometimes used privately and sometimes rented out), or land that is on revenue account because it is held in a land-related business (ie. A business of land dealing, development of land, division of land, or building).

What happens to rental losses?

In essence, the proposed legislation will mean that any excess expenses over rental income which would otherwise produce a tax loss, is carried forward to the next income year and will only be able to be offset against future rental profit or taxable gains on the sale of residential rental properties. 

When are ring-fenced losses released?

Ring fencing is to be applied on a portfolio basis, however taxpayers will be able to elect to apply the rules on a property-by-property basis.  A portfolio basis refers to the fact that losses of one property can be offset against the profits of another.  A property-by-property basis implies that the losses arising from a particular property can only be offset against future profits in relation to the same property.  If a taxpayer is applying ring-fencing on a portfolio basis, all properties must be sold within the portfolio before ring-fenced deductions can be released.  If applying ring-fencing on a property-by-property basis, in the event where the property ends up with a taxable gain upon sale, ring fenced deductions would be released.  Where residential rental properties are held under various companies, conditional upon these companies being in the same wholly owned group, transfers of ring-fenced losses will be permitted, but ring-fencing will still apply. 

Can I get around loss ring-fencing?

Avoidance provisions have been considered in the proposal to prevent taxpayers from gearing the shares in companies that own residential rental properties.  If more than half of a company’s assets comprise of residential rental property, any interest on money borrowed to either purchase shares in the company or capitalise it has to be apportioned on a pro-rata basis between residential rental property and the other assets, ie. Will be subject to the same ring-fencing rules.

What will be the effect of ring-fencing rental losses?

The introduction of the ring-fencing of losses, in combination with the previous extension of the bright-line rules to 5 years, points to a reduced appetite for investors to purchase residential rental properties.  Whether this may in fact translate to an uptake in commercial property investment instead, where losses are not ring-fenced and properties are not subject to the bright-line rules, only time will tell.  What is yet to be seen too is whether the introduction of the Bill will result in an increase in rents to compensate for the loss of deductions.  Either way, the proposed ring-fencing of losses will impact future tax planning and structuring.  The team at Giles & Liew Chartered Accountants welcome you to book in a consultation to discuss how these new rules may affect your individual circumstances and to check whether your current structures are best suited to take you forward.