New Rules on ring-fencing rental deductions
From the 2019-20 income year new ring-fencing rules apply to residential property deductions. Ring-fencing means residential property deductions can only be used to offset income from residential property. You cannot use rental losses to offset other income like salary and wages.
Under the rules, you can only claim deductions up to the amount of income you earn from the property for the year.
At present, rental property investors can deduct interest and other expenses (other than capital improvements) as these expenses relate to earning taxable rental income. In many cases, these expenses exceed the rental income, so the rental activity is loss-making although the overall investment may still be profitable due to the tax-free capital gains that may be realised on the sale of the property. Most rental property investors hold their property on capital account, so the gains made on sale would not be subject to tax.
Before the introduction of these rules, loss-making investors could use the excess deductions from their rental properties to offset their income from other sources (such as salary and wages), thus reducing their income tax liability.
The Government considered that this created an uneven playing field between property investors who are buying property in anticipation of capital gains and home buyers. Investors with loss-making rental properties were able to have part of the cost of servicing their mortgages subsidised by the reduced tax on other income sources, helping them to outbid home buyers.
The new residential ring-fencing rules are introduced to ring-fence deductions for residential properties to income from those properties. To the extent the deductions exceed the income, they cannot be used against income from other sources, such as salary and wages. Instead, the excess deductions will be carried forward for use against residential property income in future years.
Types of property subject to the new rules
The new ring-fencing rules apply to residential land – mainly residential rental properties. This includes overseas property held by a New Zealand tax resident.
The rules generally apply no matter how the property is held. The rules apply to property owned by you or:
- a partnership
- a look-through company
- a trust, or
- a close company.
The rules do not apply to:
- your main home. If you have more than one house, the main home is the one you have the greatest connection with
- property that comes under the mixed-use asset rules. For example, a family bach you sometimes rent out, sometimes use yourself, and is vacant for 62 days or more a year.
- property used mainly as business premises
- property that will be taxed when it’s sold, regardless of when you sell it. This includes property held in land related business and property bought to sell.
- property owned by companies (other than close companies)
- employee accommodation (in most cases)
The residential ring-fencing rules apply from the start of the 2019–20 income year i.e. from 1 April 2019.