Ring-Fencing of Residential Rental Losses
Recent changes to the Income Tax Act have been passed as part of the Taxation (Annual Rates for 2019-20, GST Offshore Supplier Registration, and Remedial Matters) Act 2019, which became law on 26 June 2019.
The changes limit the ability to offset losses from residential rental property against other income – Subpart EL (Allocation of deductions for excess residential land expenditure).
The rules apply from 1 April 2019, i.e. for the year ended 31 March 2020 and future years. A summarised list of the changes is shown below:
Section EL 1
(a) limit a person’s deductions for expenditure incurred in relation to residential land to income derived from the land; and
(b) suspend deductions for the excess expenditure for the income year in which the expenditure is incurred; and
(c) provide that the excess amounts are carried forward to later income years in which the person derives residential income; and
(d) release the excess amounts on fully-taxed disposals of land.
Section EL 4
If the expenses in relation to your residential rental property are greater than the income, then the excess amount is carried forward to a later year to offset against residential rental income. You can no longer offset your residential rental losses with other types of income in order to reduce your income tax liability.
Section EL 6
If you own more than one residential rental property you can choose to apply the rules on a property by property basis if you wish, e.g. carry forward a loss from one particular residential rental property, while paying tax on the profit of another property. There are limited scenarios where you may want to choose to do this. The rules allow you to treat your residential rental properties as a portfolio, to offset a loss in one property with a profit in another, but you do have the option of treating each property separately if you wish.
Section EL 10
Exclusion for land held on Revenue Account. If when a residential rental property is disposed of it gives rise to income (under land sales provisions) – then any losses from renting the property will not need to be ring-fenced and carried forward. An example would be a property developer who sells residential property for a profit.
Section EL 11
The rules don’t apply to residential land owned by a company, other than a ‘close company’. It is likely that the majority of companies that own residential rental property will be close companies, e.g. husband and wife with 50/50 shareholding. Look Through Companies (LTCs) are by definition close companies.
Section EL 12
These rules don’t apply to Mixed Use Assets (e.g. the family bach that gets rented out for some of the year, Mixed-Use Asset rules apply).
Section EL 16
Interests in residential land-rich entities. The legislation has been designed to cover situations where different funding arrangements are used. It applies when a person is able to claim an interest deduction for an amount borrowed to acquire an interest in an entity that owns residential rental property. Any interest deduction available on the amount borrowed is limited to the net residential rental income to which the borrowing relates. Any excess interest in relation to the residential rental property is carried forward to a later income year to be offset against net residential rental income.
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