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Ring-Fencing of Losses
In 2019, the New Zealand government brought in a new law that ring-fences rental property losses. Here’s what investors need to know.
- Before April 2019, property investors could deduct tax from their overall income when they made a loss on their property.
- After April 1st 2019, the ring-fencing of losses law makes this impossible.
- The IRD explains that the aim of this policy is to even the playing field between investors and homeowners.
What is Ring-Fencing?
Ring-fencing is any system that divides someone’s financial assets. Essentially, it creates a “fence” around a segment of their income.
In New Zealand, if you make a loss on your investment property, you used to be able to offset your losses against the rest of your income. This creates an incentive for investors to put money into residential property, as a loss can reduce tax liability overall.
The process is known as negative gearing.
Negative gearing is when the cost of maintaining a property costs more than the return from rental fees. This is sometimes seen as an advantage as it means you could be eligible for a tax deduction.
What Does the New Law Outline and How Does it Affect Me?
The new ring-fencing of losses regulation means that investors will no longer be able to offset losses for tax deduction purposes.
Instead, the loss will be “fenced off” and will only be deducted from future property income.
According to the government, tax deductions from negative gearing mean investors have a significant financial advantage over would-be homeowners.
In their 2018 officials’ issue paper on ring-fencing rental losses, Inland Revenue explains that the primary reason for this policy change is fairness. The loss ring-fence policy aims to “level the playing field” for New Zealanders looking to get up the property ladder.
How Will This Policy Affect Property Investment in NZ?
As of the end of 2018, the IRD was still unsure what impact this policy would have on property investment in New Zealand.
The new law means investors will no longer be able to use negative gearing to increase their return on investment. However, it is still unknown how this will affect the New Zealand property market overall. This comes at a time when the Auckland property market is already a tension point for New Zealand.
Andrew King of the Property Investors Federation predicts that new rules like loss ring-fencing could discourage new builds. Ultimately, these tax deduction changes could result in less property investors and more homeowners. However, it is important to remember that not all investors are solely in the business of property!
For example, a working couple may invest in a rental property.
Previously, if their rental lost money due to maintenance and interest, they could get a tax break against their regular salaries. This meant that they could make some of it back within the year.
With the new laws, these losses might be passed on in the form of rent increases so that it is worth it for the couple to continue owning an investment property.
Therefore, even if the policy evens the playing field for potential home buyers as it intends to, it could still leave renters in the midst of a housing crisis!