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Ring-fencing rental losses

Chapter 3 - Property the rules will apply to

3.1 Under the proposed changes, the loss ring-fencing rules would apply to “residential land”. The rules would use the definition of “residential land” that already exists for the bright-line test.

3.2 The rules would not apply to:

  • a person’s main home;
  • a property that is subject to the mixed-use assets rules (for example, 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[6] (that is, a business of land dealing, development of land, division of land, or building).

Definition of “residential land”

3.3 There is already a definition of “residential land” in the Income Tax Act, which is used for the bright-line test which taxes sales of residential land bought and sold within two years. It is proposed that the loss ring-fencing rules apply to land within that definition – with the exceptions discussed below. Using the definition already in the legislation would avoid the additional complexity of having different definitions for different rules.

3.4 “Residential land” means:

  • land that has a dwelling on it;
  • land for which there is an arrangement to build a dwelling on it; and
  • bare land that may have a dwelling built on it under the relevant operative district plan rules.

However, “residential land” does not include:

  • farmland; and
  • land used predominantly as business premises.

3.5 “Residential land” is not limited to land in New Zealand – it would extend to overseas land. This means that losses from overseas residential rental investments could not be offset against other income in New Zealand.

3.6 Apart from the exceptions below, the rules would apply to all residential land, whether or not it is currently rented out, including bare land. This is because the proposed rules are aimed at levelling the playing field between residential property speculators/investors and people looking to buy their own home or land to build a home on.

Main home

3.7 The proposed loss ring-fencing rules will not apply to a person’s main home. This is to ensure that a person who has a boarder in their main home, or who rents out a spare room occasionally, would not have to apply these rules, which are primarily targeted at residential investment properties. The meaning of “main home” would be the same as for the bright-line test, which has a main home exclusion.

3.8 A person can only have one main home at a time. If someone has more than one residence, their “main home” would be the one they have the greatest connection with. That would be determined by looking at factors such as:

  • the amount of time the person occupies the dwelling;
  • where their immediate family live;
  • where their social ties are strongest;
  • their use of the dwelling;
  • their employment, business interests and economic ties to the area where the dwelling is located; and
  • where their personal property is kept.

Trusts

3.9 A significant number of family homes in New Zealand are owned by family trusts. The definition of “main home” would therefore ensure that a home owned by a trust can be regarded as a main home.

3.10 Like with the bright-line rules, we suggest that a dwelling owned by a trust only be considered a main home (so not subject to the loss ring-fencing rules) if it is the main home for a beneficiary of the trust, provided that a principal settlor of the trust does not have a different main home.

3.11 This restriction would ensure that trust ownership cannot be used to claim multiple properties as main homes, and so not subject to the loss ring-fencing rules.

Mixed-use assets

3.12 The existing definition of “residential land” in the Income Tax Act would also include holiday houses that are sometimes used privately and sometimes rented out. However, many such properties would be subject to the mixed-use asset rules, which already provide for the quarantining (or ring-fencing) of losses where there is low income-earning use of the asset.

3.13 We suggest that property subject to the mixed-use asset rules should be scoped out of the rental loss ring-fencing rules, because the mixed-use asset quarantine rules will cover most if not all mixed-use asset losses. We are interested in feedback on whether property subject to the mixed-use asset rules should be outside the scope of the loss ring-fencing rules.

Revenue account land in dealing, development, subdivision and building businesses

3.14 Land that is held in certain land-related business is on revenue account, so the profits on sale are taxed. This applies to land held in dealing, development, subdivision, and building businesses.

3.15 At balance date, taxpayers in these businesses are likely to have a number of properties on hand, though they may not be currently rented out.

3.16 As discussed in chapter 5, it is proposed that residential rental or other losses could be used against taxable land sales to reduce the taxable gain to nil, with any further unused losses remaining ring-fenced to future rental income or taxable income on land sales. While taxpayers in the business of land dealing, development of land, division of land, or building may have losses in respect of properties on hand at balance date, those losses being able to be used against income from other sales or rental activity in the year would mean that their businesses would be unlikely to be disadvantaged by the ring-fencing rules. In most cases the income from their sale or rental activity would be expected to exceed their losses.

3.17 However, in any overall loss-making year, we do not consider it necessary to ring-fence losses for land held in these businesses. There is not the same concern  about any of the deductible expenses in relation to land in these businesses relating to untaxed gains, as all of the businesses’ land is on revenue account. Therefore, we propose that the ring-fencing rules not apply to land that is on revenue account because it is held in a land-related business.[7] This would enable taxpayers in these businesses to use losses arising in any year against other income – for example within their corporate group (as they are likely to be companies).

Property owned by companies and trusts

3.18 There is an argument that the loss ring-fencing rules should apply only to individuals (that is, natural persons),[8] and not to companies or trusts. This argument could be made because company losses are effectively ring-fenced inside the company, as are losses in a trust.

3.19 However, such an approach would leave open the possibility of individual speculators or investors operating through a company or trading trust, holding their residential properties in that vehicle, and offsetting the losses against their labour income. It would also mean that a family trust holding residential rental property and also some other investments could offset rental property losses against income from the other investments. For example, it would not be fair for a professional operating through a company or trust to not be subject to the ring-fencing rules where another person operating as a sole trader would be.

3.20 It is acknowledged that there may be some compliance costs for some corporates that own some residential property incidentally to their business. However, it is considered that limiting the ring-fencing rules to individuals would significantly undermine the fairness of the rules. For this reason, we suggest that the ring-fencing rules should apply to all taxpayers, not only to individual taxpayers.

 

6 As per section CB 7 of the Income Tax Act 2007.

7 As per section CB 7 of the Income Tax Act 2007.

8 This would include a natural person with an effective interest in a look-through company with residential property losses.