Last year ended with the disappointing news that ring-fencing of rental property losses would no longer be permitted, despite it being available to all other forms of tax losses. Along with the Bright Line Test, this is another tax change which will only apply to rental property.
Claiming tax losses on rental property has been presented as a tax loophole available to rich property owners so they can make tax free capital gains.
"The tax system is biased towards the relatively affluent home-owning class, while the poorer renting class miss out" says economist Shamubeel Eaqub. He has campaigned for many years to ring-fence rental property losses, claiming that this would ensure residential investment properties stand on their own merits.
What Eaqub fails to realise is that providing rental property, especially in the first few years, is extremely difficult financially. Being able to claim losses against other income provides assistance at exactly the right time. Ring-fencing rental losses is like replacing the first obstacle in a hurdle race with a high jump poll. Because many people cannot clear the first hurdle, they cannot enter the race.
It seems incredible that at a time when we are facing a shortage of rental properties and rental prices are increasing at a faster rate than inflation, Government looks to introduce a policy that restricts rental property supply.
It is hard not to conclude that there is a campaign to remove private rental property suppliers from the market. Tenant advocates appear to have been persuaded that large financial institutions would be better at providing rental properties in New Zealand. They also believe that not-for-profit organisations would be better at providing rental accommodation, although it is hard to see how.
The last Government offered the not-for-profit sector properties at a reduced value, guaranteed the rental income and provided rental top-ups at higher rates than the accommodation supplement. despite having all this on a plate, the not-for-profits said they couldn't make it work and Government would have to give them the properties for free.
The new rules will fully come into effect this April, so there will be no slow introduction which was promised during the last election.
The NZPIF proposed that the law change should be applied on a portfolio basis and this has been accepted, which is some good news. It means that people with other positively geared rentals may still be able to buy and provide more rental property. However there is little doubt that many people who would have bought and provided a rental property will now no longer be able to do so.
With an immediate and full introduction of ring-fencing, some highly geared rental owners could face serious cashflow problems. Hopefully they will be able to either increase their rental prices or find extra funds somewhere else rather than be forced to sell. Unfortunately it is a certainty that some people will be placed into this situation.
In our submission to the IRD, the NZPIF recommended that there should be an upper limit on claiming losses rather than a complete ban. This would reduce the requirement for rental price increases, lower the number of rentals that would need to be sold and minimise the effect on rental property supply. It is extremely disappointing that this proposal was not considered.
As with most ill-conceived law changes, the unintended consequences will lead to opportunities for some. This will involve good planning for your investment strategies over the coming year. The NZPIF and associations all around the country will be looking to help our members handle this new and unfortunate situation.