I wrote about loss ring-fencing in my January article, and it is still a hot topic. With the rules to take effect from April 1, 2019 and the legislation still not finalised, there are a number of questions that remain. I address some of these using case studies, which could well apply to you.

Case Study 1

An individual personally owns one tax positive residential rental property and one that is tax negative. Can the rental profits of one property be offset against the losses of the other?

Under the draft rules, a taxpayer who owns two residential rental properties can by default offset the profits of one against the losses of the other. Note that offsetting profits and losses of multiple rental properties held by the same owner requires you to apply the “portfolio” method of loss calculation. The draft legislation also permits election to use a “property-by-property” basis. On this basis, the losses of one property cannot be offset against profits of another.

Case Study 2:

What if the rentals are not held by the same entity? For example, an investor owns two LTCs with the shares either held by the same person(s) or by the same trust. If one LTC owns a property that is making a tax loss and the other owns a property that is making a tax profit, can the profits and losses be offset?

Based on the draft rules, we believe it will be possible to do so. Again, this assumes you have not elected to offset losses on a property-by-property basis. Despite the properties being owned by two different legal entities, for income tax purposes the assets of an LTC are deemed to be held by the shareholders. Therefore, the shareholders of the two LTCs would be deemed to hold all of the properties for tax purposes, thus allowing offsets.

Case Study 3:

What if the companies in question were not LTCs but were “ordinary” companies? Imagine a trust that owns 100% of the shares in two companies. One company holds residential rental properties that are profitable, and one holds loss-making properties. Can the losses of one ordinary company be offset against the profits of another?

The draft rules contemplate the grouping of losses and would therefore allow residential rental losses of one ordinary company to be offset against residential rental profits of another, but only if the two companies have identical shareholding.

Case Study 4:

What about if a trust is part of the picture? For example, if an individual has a lossmaking rental held in an LTC with the losses being attributed to them personally, can those losses be offset against income distributed from a trust that owns a tax positive rental property?

Although the draft legislation does not specifically address this sort of split ownership, it appears that you not allowed to offset personal losses against taxable rental income allocated to you by a trust.

These are just some scenarios that can arise. Keep an eye on developments and seek advice prior to implementation of the legislation to get the best possible outcome.

Rules Socially Inequitable

Investors supplying property are being ambushed with a change of rules that is retrospective, when it should be prospective. In my opinion, the rules should only apply to property purchased after the date the legislation is implemented, but this is not the case.

When interest rates rise, lower income investors will be served as insolvent dishes to higher net worth investors, which is contrary to Labours’ social agenda.

Additionally, this legislation gives existing investors who are tax positive a huge advantage over new investors. This is because on a portfolio basis, existing investors with taxable income from property can offset that income against losses on new investments.

GRA will be holding a webinar on loss ring-fencing once the rules are finalised – to be informed of such events, keep an eye on our website (www.gra.co.nz/events) or subscribe to our newsletter