Hot on the heels of introducing restrictions to property ownership by non-residents and the extending of the “bright line test” for taxable property sales from 2 years to 5 years, the Labour-led coalition government is now following through with another of its property-related proposals aimed at levelling the playing field for taxpayers.
Whilst most people were busy buying Christmas presents and thinking about their upcoming summer break, in late 2018 Parliament was introducing the “Taxation (Annual Rates for 2019-20, GST Offshore Supplier Registration, and Remedial Matters) Bill”. If you are an offshore retailer or a regular Amazon shopper you may have been paying attention due to concerns over changes to the GST rules for online purchases. However, if you are the owner of residential rental property you might have missed one of the more fundamental “remedial matters” contained in the Bill.
The Bill currently before Parliament aims to restrict the ability for landlords to offset rental losses arising from residential property against their other income sources, effectively further eroding the tax incentives associated with residential rental property.
Under general tax rules, income tax is imposed on a taxpayer’s net income after offsetting allowable deductions and expenses, including the offsetting of any losses made from rental property activities. In many cases, landlords may not intentionally be making losses but rather might have made a loss due to unforeseen maintenance expenditure or perhaps the unexpected departure of a long-term tenant. However, there is a strongly held belief that many landlords are happy to continually make losses or intentionally “negatively gear” their properties knowing that they create both an income tax advantage by making a loss now and later by realising a long-term tax-free capital gain on the eventual sale of the property.
Commentary to the Bill argues that, to the extent the expenditure continually outweighs the income, the owner is placing a greater focus on the long-term tax-free capital gain. Consequently, the additional expenses should therefore be viewed as relating to that eventual gain and should not therefore be deductible for income tax purposes unless the gain is also taxed. The commentary also observes that the ability to offset elements of a landlord’s expenditure through tax relief also puts such investors in a position to outbid other prospective purchasers who are simply looking to buy a home to live in.
The proposals in the Bill will effectively ring-fence any future losses and any accumulated losses such that they can only be used to reduce future taxable property income, either on a property by property basis or on a portfolio basis.
Furthermore, the proposed rules are intended to apply to “residential land”, meaning they will apply to existing residential rental property, land that is already under an arrangement to have a residential property built on it and bare land that is capable of having a residential property built on it under local zoning rules. However, the limitation would not apply where any property is taxable upon sale (i.e. land owned for development, subdivisions etc).
For those landlords who effectively make a one-off loss due to planned or unforeseen additional expenditure, or from an unexpected period without a tenant the changes will effectively represent just a timing difference and the loss will be able to be claimed when a rental profit is made in subsequent years. However, for those landlords who effectively run a highly leveraged residential property portfolio where annual net profit is perhaps not the main focus, the proposed changes may prompt a strategy rethink once the tax advantages are watered down.
The Bill is currently working its way through the parliamentary process and submissions are open until 28 February 2019, with a report back date of 11 June 2019. However, if enacted in its current form the provisions will apply from 1 April 2019.
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