Ring fencing rules 'will have little effect'

Property

Property information and analytics company CoreLogic believes the new tax treatment for investment properties will not have much impact on the number of rental properties available

22nd May 19, 10:45am by David Hargreaves

Property information and analytics company CoreLogic is talking down the likely impact of new rules around 'ring fencing' of tax losses on investment properties.

CoreLogic senior property economist Kelvin Davidson says in the firm's Market Pulse publication that while some investors - especially those new to the game and/or with a big mortgage and hence greater likelihood of a loss - will be hit quite hard by this rule "on the whole, we’re doubtful that the ring-fence will dramatically affect investor confidence or significantly reduce the stock of property in the rental sector".

He says "equity rich" landlords might just "snap up" sold properties thereby limiting the adverse effect on the number of available rentals.

The ring fencing proposals are part of a bill currently going through the select committee process ahead of being returned to Parliament. In short, the proposals mean a rental loss can no longer be used by an investor to reduce their tax bill on non-property income. However, rental losses on one property can be used as deductions against other rentals in a portfolio.

Davidson says it would appear that it is a mere formality the proposals will become law and when it does the ring fence will effectively be imposed for the current tax year starting 1st April 2019.

"In other words, investors need to be accounting for the ring-fence now – i.e. running their sums on the basis that a rental loss can no longer be used to reduce the tax bill on non-property income(s)."

But in assessing that the proposals will not have much overall impact on investors' behaviour, Davidson makes a couple of points.

"First, because of the loan to value ratio (LVR) restrictions, investors have required a deposit of at least 30% for several years now and, on average, will be less likely to be making operating losses than in the past – hence, less likely to actually be utilising the tax advantage. Sure, many will still be using it. But it’ll be less common than in the absence of the LVR rules.

"Second, and perhaps most importantly, it’s a ring fence, not complete removal. Investors will still be able to use losses to reduce their tax bill, just only within a property portfolio, not against non-property income."

Davidson says it's "reassuring" to look back at investor behavior when the depreciation allowance was removed in April 2011.

"This was also a significant change in the rules around property investment, yet our Buyer Classification figures show that the upward trend in the share of purchases going to mortgaged investors barely paused for breath."

Davidson does say however, that property price rises more generally were starting to "kick into gear again" around the time of the depreciation removal and the gains available may have "swamped" the effect of its removal.

"And clearly, that factor isn’t as strong now, with values flat or slightly falling in Auckland and Christchurch for example, and slowing in many other parts of the country.

"All that said, another factor to keep in mind here is the tighter availability of new interest-only loans in the past few years, as well as the reduced ability for investors to roll over existing interest-only lending."

Given that interest-only loans (and hence lower mortgage payments) are an important tool for negatively geared landlords, Davidson says it’s conceivable that some will have already looked at their sums (regardless of the ring fence proposal) and decided to sell properties that don’t stack up anymore.

"This may have affected rental supply in some areas and would be another factor helping to explain the gradual slowdown we’re seeing in property values around the country.

"Of course, this would only serve to lessen the potential effect when the new [ring fencing] law does actually come into force.

"Moreover, let’s not forget that just because a landlord sells their property, it doesn’t necessarily vanish from the rental stock – it may well be snapped up by another investor, perhaps with more equity behind them."

In addition, Davidson says rather than selling, landlords may just hold their properties for longer than they planned in order to compensate for the effect of the ring-fence on their expected return.

"That would just reinforce what we’ve already started to see in the past year or two – that is, investors holding for longer than in the past, and also relative to other buyer groups, such as first home buyers."

"Bottom line, we doubt that the looming tax ring-fence for rental property losses on its own will drive a sea-change in investor behaviour," Davidson says.

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37 Comments

by rastus1 | 22nd May 19, 10:59am 1558479599

..I love how these experts always refer to property as being 'snapped up".

The only thing that will be 'snapped up' will be the tax on the paye that was being offset!

More progress to level the playing field for home owners. Good work.

by Boatman | 22nd May 19, 2:07pm 1558490874

@rastus , just how is this going to 'level the playing field " ?

Lets not forget that Housing New Zealand is already against the ropes and housing people in motels due to a housing shortage .

Why would anyone want to do anything to stop the private sector supplying houses to the market to rent , when the State clearly cannot do so ?

Ringfencing the losses should should be phased in to allow an orderly adjustment to the market .

Right now the Government is treating what it perceives as the housing problem rather then the symptoms of the housing problem.

by rastus1 | 22nd May 19, 4:35pm 1558499732

because I cannot offset my rates, insurance, repair and maintenance against my other income. A landlord can.

And this landlord advantage means they can always pay more. Most landlords are not supplying houses, merely own them.

by Trevor42 | 22nd May 19, 6:13pm 1558505600

Why as an investor would I want to pay more? That's a sure fire way to lose your money.
The reason you cannot offset your housing expenses is that you are not a business, i.e. taking in taxable income and incurring taxable expenses in the process. You as am I in my private capacity, are not able to claim tax deductions for my own private expenses, even on my owner-occupied home. I can only claim taxable expenses on my income producing business premises, which happens to be a residential rental home, just like a B&B or shop. There is nothing, I repeat nothing, underhand in this. Get over yourself.
If you took in a boarder, i.e. business income, then you too could claim the relevant taxable expenses incurred.

by rastus1 | 23rd May 19, 8:47am 1558558041

You can afford to pay more to secure the property as an investor than the aspiring owner who missed out. This due to the deductions as an investor you can claim, but as a home owner not. Nothing to 'get over'. Just the failings of yourself to understand perhaps?

by Pietro | 23rd May 19, 9:28am 1558560505

Spot on, Rastus. Why should one class of property owner get a huge tax break when others don't?

by Trevor42 | 22nd May 19, 5:59pm 1558504746

Please note that there will be no EXTRA tax paid through this policy. It will be just delayed until the property, through inflation becomes profitable again and the deferred tax credit will then be deductible on what otherwise had become a taxable activity.

by Boatman | 22nd May 19, 10:09pm 1558519752

@Trevor42 , thanks for pointing this out.

Some folk seem to think that all of a sudden there is going to be a massive tax take on rental income , and they miss the point completely .

Out of our 5,000,000,000 or so population fewer that 130,000 are landlords , and they are people stupid enough to want to have tenants .

Investing in residential accommodation for income is a business , like any other , and should be treated equally .

by Market Interest | 23rd May 19, 11:31am 1558567887

Crikey, I knew the actual immigration numbers were steeper than the figures published, but 5bn might be a bit of an exaggeration.

Fair point, though. If the house is an asset used for business purposes, then it should be treated equally.

The problem I've always had is how the Working for Families scheme was being rorted. This enabled borrowing large and making losses in perpetuity to drop household income below the WFF thresholds. Tax creep has probably eased this over time, but surely it could be argued that perpetual losses indicate that the intent of the purchase was NOT investing in a profitable business.

by sadr001 | 23rd May 19, 8:16am 1558556188

Consider this hypothetical: Investor A has a rental portfolio that makes a loss of $15,000pa and an annual income of $48,000 from other sources. After 2 years Investor A sells a property and is caught by the bright line test having made $30,000 capital gain in the sale.

Under the ring fencing rules Investor A is able to save his losses which would previously have been used against his other income ( resulting in 17.5% tax back ) until he enters a year in which he would otherwise have to pay 30% tax on some of his income (capital gain from sale of a property) and then use those saved up losses from multiple years to offset this income from a higher tax bracket!

Now imagine what would happen if Investor A was capable of bundling various businesses in with his residential real estate holding companies? Through clever accounting I envisage this ring fencing being a mechanism through which those with astute accountants will be able to actually reduce their overall tax bill.

It appears to me that the government is increasing the complexity of the tax system in order to enable those who can afford accountants to benefit at the expense of those who can not. I have actually found that the current government has become more and more attractive as the term progresses, largely because of what I can only imagine are the unintended consequences of poorly thought out legislation.

by rastus1 | 23rd May 19, 11:00am 1558566011

Nice epistle..but you miss the main point. Timing is money. They cant get the deduction now...which is what they need now to fund the loss. That drives down the ability to pay now and thus ability to outbid home owners. Driving down prices. Marvelous.

If you don't want a complex tax life, keep away from pushing up house prices and using our young people as your cash cow.

by sadr001 | 23rd May 19, 11:44am 1558568656

I’m in my mid 20s :) . Investors are apparently willing to use the 28% corporate tax rate even though it means not being able to use money taxed at that rate as though it were their personal funds because the 5% difference is significant. In my opinion if residential real estate is the only vehicle that allows you to trap losses to be used at an arbitrary future point that suits you better then you might find that a whole different grade of (much scarier) Investor is attracted to it as an investment.

If it is absolutely necessary to ring fence rental losses I believe that it would be prudent to also introduce the option to allow businesses to elect to ring fence some or all of their losses so as to prevent residential property investment from becoming a tool for corporate tax optimisation.

Just the idea of a huge number of houses being bought as say a speculation on future tax rates ( you pay a lower rate now because you believe that the rate will be higher in the future, so you trap your losses for use against that future rate ) scares me. As the interest rate drops the value of having the money now as opposed to trapping it as non-interest bearing losses gets lower making it more attractive.

Or maybe a company just wants to book losses in a particular future year so that it can adjust its sale price. The possibilities are endless!

by Joe Wilkes | 22nd May 19, 7:51pm 1558511465

Rastus. What you need to assess is the narrative, why it’s suggested there won’t be an effect on asset values because of negative gearing. There will be but it pays to look at who pays the salaries of those that do the reporting.
Corelogic major shareholders in link below. Top 4 are all US listed firms, including Vanguard an asset manager and Blackrock. Remember they have a bigger looming pension crisis in the US than anyone and it’s 70% invested in stocks whilst we’re 70% invested in the property they need to talk up.
https://m.marketscreener.com/CORELOGIC-INC-6275906/company/

by mikekirk29 | 22nd May 19, 9:37pm 1558517837

Excellent Joe

by rastus1 | 23rd May 19, 10:52am 1558565571

Oh I get that Joe. The media report always roll out some bank economist or some real estate rep as the 'experts'. My online reading is on both sides...then come back to msm and you wonder if a parallel universe is operating.

Listening to msm you would think all the reasons why property was booming a few years back are now irrelevant - apparently now these drivers have gone the market will be just fine - just needs a tweaking of interest rates and removal of LVrs. Magic.

by Boatman | 22nd May 19, 2:00pm 1558490418

This will not end well .

Of course the ring -fencing losses will not have an immediate effect, but in the long run, it will .

It always takes time for the consequences of radical changes such as this, to manifest themselves

It will further ensure that investors will stay well clear, simply because they will not be able to carry the shortfall, or be unwilling to do so

It will have absolutely no effect on prices generally because we are still receiving more inward migration than we can cope with , so housing demand remains high while supply remains constrained .

What it will do , however , is create a real headache for Government , because we really do need people to supply houses to rent ................... the State cannot do this , they have neither the money or the capacity to be the house-supplier-of -last - resort to all and sundry.

by Yvil | 23rd May 19, 4:20pm 1558585207

Excellent comment Boatman, right on the money (as demonstrated by the total lack of thumbs up)

by RickStrauss | 22nd May 19, 2:56pm 1558493762

How horrible and outrageous that people might be taxed more equitably.

by Trevor42 | 22nd May 19, 6:02pm 1558504928

There will be no difference in the tax payable, only the "when". These isolated tax losses will be claimed at a later date when the property eventually becomes profitable, thereby delaying the tax that would otherwise be paid.

by Boatman | 22nd May 19, 9:53pm 1558518790

@RickStrauss ........... you really dont get it do you ?

The losses that are currently being "offset" against other income , will still be losses , and the investor will be entitled to recover those losses when the property starts to make a profit , thus reducing his tax liability at that time .

its a zero sum game

As things stand the losses claimed or offset are subject to a clawback on sale, or tax as soon as there is a profit from the rents , so little has really changed , other than a timing difference AND a huge disincentive to investors to supply rental stock.

And that's the crux of the matter , these tax incentives are in place to encourage the private sector to supply rental stock to the million or so new migrants we have seen arrive here over the past decade and a half , many of whom cannot afford to buy a home , and may never be able to .

by RickStrauss | 23rd May 19, 1:56pm 1558576570

1. Assuming investors have not had a role in pushing prices up, thus affecting home ownership affordability in the first place.
2. How many new builds have you as an investor added to supply? Seems like more investors are buying existing stock than creating new supply.

by Sluggy | 22nd May 19, 3:30pm 1558495859

Its amazing that we have to legislate to stop people purposely entering into a business that sees them losing money from day one, gambling on market appreciation to fulfill their business dreams and aspirations.

by Boatman | 22nd May 19, 10:00pm 1558519225

@sluggy ........... nothing is amazing about this at all , these "incentives" to negatively gear property were openly encouraged by among others , previous Labour Governments, to encourage the private sector to supply rental stock to the market .

And thats the crux of it , without allowing the tax deduction of losses ( as is the case in any business venture) we would be in a housing crisis 100 times worse than we are already .

The state cannot supply housing stock to everyone , many people will never afford to own a house in their lifetimes, and now we risk strangling the supply of rental stock .

Like I have said , this will not end well, especially for renters

by Pietro | 23rd May 19, 9:40am 1558561235

I suspect that the state can afford to supply housing, although not 4 bed, 3 bath ones in the grammar zone for freehold ownership, but sensible, warm homes for fair rent. It's been done before on a massive scale, here and elsewhere. A simple matter of resource allocation and will.

by Yvil | 23rd May 19, 4:24pm 1558585496

Are yo for real? The "state" as you call it, won the election by promising to building 100'000 affordable homes (and reducing immigration), try reading a bit about how well these 100'000 affordable houses are coming along

by Wrong John | 22nd May 19, 4:43pm 1558500223

With the end of the big cycle (75-85 years - or the average human lifetime) since its beginning in 1945 I feel there will be some factors in play today, that we may not have seen in our lifetimes before.
1. The big one is the amount of elderly money going into retirement setups, most of it never to be seen again by the families involved. I know of many of these. You can here the sucking of money from here.
2. Without immigrants, housing affordability would not be a problem. However, this is a reality in most civilised societies these days due to falling birth rates right across the board. This is fundamentally changing our culture right in front of our very eyes & we are powerless to stop or effect it. Welcome to the great big melting pot as the song says.
3. Big cycles historically tend to represent big changes, especially in dominant cultures which have oftentimes become rich & powerful & wealthy (& lazy). Indeed, as we watch every day on our screens, the big cycle is taking place before our very eyes, and once again, we seem to be unable or unwilling to effect any non-change (as, in case you were wondering, we are the rich pricks these days).
4. The rise of the Beast. There is no stopping China these days. Trump is trying but the dragon has its ways & means & they are formidable. This will not end well, for any side. Once again, history repeats, there is always a challenger culture to repel - or worse. And ....
5) it's here (in China) that we find the genesis of the next blowout - the great Chinese Tier 1 (& tier 2) property market bubble. It is enormous. Some of the numbers still coming out today are astonishing, although I see the reality is slowly setting in further down their food chain (the lessor tiers). When this goes, as I suspect Mr Trump is hoping for, this will be a tsunami of epic proportions. And it will be global. And, once again, you & I can do nothing but watch it happen. Indeed, it is beyond most of us & I suspect it is probably even beyond the great Chinese Communist Party itself when it strikes.
Summary: It is in this context that you should be very careful when making large purchases that take a lifetime to pay off.

by Joe Wilkes | 22nd May 19, 6:41pm 1558507265

A very well constructed comment. Thanks for that.

by theglc | 22nd May 19, 8:04pm 1558512249

Got to congratulate Labour for another sensible policy!

Well done!!!

by Boatman | 22nd May 19, 10:02pm 1558519325

@thegic , its really not a sensible policy at all if you consider the possible consequences of deliberately discouraging the private supply of rental stock

by Nzdan | 23rd May 19, 10:34am 1558564486

Are Landlords building new rental properties to supply the market?

by Shoreman | 24th May 19, 1:51pm 1558662715

Theglc - I think you have not thought this one through. At best in our history less than 70% of households were owner/occupied ever. Not everyone can achieve home ownership for multiple reasons ever.

I believe the state provide 25% or less of the rental stock in NZ currently. We do need people willing to take on ownership of rental accomadation, it is a responsibility and commitment.

There is a general feel out there that Landlords are on the gravy train and are rich and heartless. I'm sure there are some that could be in that camp but most Landlords own 1 rental maybe 2 and work their butts off to make it work. Generally everything that can be done by the owner is because paying someone else for all those small jobs would make it uneconomic.

Making it less attractive for new Landlords is helping to create a bigger problem down the road, another foolish policy by the COL.
Just like changing the cost of from tenant to Landlord for moving in, tenants choose to move not Landlords. In the cases of Landlords asking the tenant to move that should be covered by the Landlord.

The result is every rental agency in the Country is now more picky and require an extra 1 week bond, and an extra weeks rent added to the rent. Stupid short sighted policy designed to fool the Labour pool of voters that their Government is fixing things for them

There is nothing easy being a Landlord try it sometime then you will be in a position to comment. It was the Clark/Cullen Labour Government that had forsight to encourage Landlords to provide accomadation knowing the State will never be able to.

And yes I am a Landlord have been for 36 years and have made many longterm friendships from tenants over the years. Providing tenants play their part in looking after my properties I only raise rents after 5 years so many have been there for much longer. It is an easy win win both ways, stable tenants are a Landlord's dream.

by Adam B NZ | 23rd May 19, 8:08am 1558555734

There are around 630,000 rental properties in NZ, of that about 40% are negatively geared on interest only loans. It will be interesting to see how many investors that will want to hold on to negatively geared property with little tax benefits and no capital gains in sight? Especially when the next recession hits? Personally I believe we will see quite a few sell up as the sentiment changes further. Many already are and the debt burdens are getting snapped up by many first home buyers that don't know any better.

by Theoracle | 23rd May 19, 8:35am 1558557350

I have rental property bought years ago that houses over 20 people, most of whom could never afford to buy due to age, being retired and ill health, some are on sickness benefits and have severe disablement. I have good working relationships with all of them. It's the property managers who tend to cause issues.

All pay below market rent and are allowed pets. Keeping on top of maintenance is very costly and constant but a priority. Debt is repaid principal and interest which takes a massive chunk out but at least it's coming down.

Anyway putting that aside I am now in a genuine quandary with the constant changes and higher and higher regulations being imposed when I'm already doing more than many landlords, so the tenants say.

Every year the rates and insurance skyrocket yet the rent can never keep up. So I go backwards on that. Then there are the higher and higher standards required, like stopping drafts completely by 2021.

This is hard to do with timber joinery. Fans and heating and insulation were in place years ago before the legal requirement.

Now there is the imminent insurance hassle with climate change and councils declaring emergencies. This could drop property values a lot. Not to mention what's been said here about boomers cashing out.

If I keep renting the property the rents only seem to go up but not by much, yet there is massive demand.

But if I sell many of my guys will literally be homeless. The tenants implore me not to sell and I don't want to but it is getting to the point where I feel I may have no option as it's getting too hard from every corner.

This is the dilemma.

by blobbles | 24th May 19, 10:23pm 1558693438

I never get this. "When I sell all of my rentals, the people in them will be homeless."

Do you burn the rentals down when you sell them? Or is the person buying them from you going to empty them of 20 people and put 3 people in there instead?

Sell or buy, it doesn't change the housing supply.

by Theoracle | 23rd May 19, 9:36am 1558560962

Anyway putting that aside I am now in a genuine quandary with the constant changes and higher and higher regulations being imposed when I'm already doing more than many landlords, so the tenants say.

This is hard to do with timber joinery. Fans and heating and insulation were in place years ago before the legal requirement.

If I keep renting the property the rents only seem to go up but not by much, yet there is massive demand.

This is the dilemma.

by South_Island_Simon | 24th May 19, 10:17am 1558649821

Many people predict housing armageddon and many predict long term wealth from housing. I'm in the "its very late if not past midnight for this party" group.
The things that concern me are that;
1/ Many businesses and people are employed in the residential house building.
2/ Many people employed in the housing industry are also invested in it by owning rental properties.
3/ NZ GDP growth is significantly dependent on building and fitting out new houses.
4/ Our major trading partners China and Australia have a dependance on and arguably an over investment in housing.
These things act like leveraged investments on the way up. People heavily invested experience rapid increases in wealth. The trouble is what gets amplified on the way up also gets amplified on the way down.
Apparently it's called balance sheet inversion and it's a bad idea.
I think it's not a coincidence that the Reserve Banks of NZ and Australia are closely scrutinizing their banks and insisting on higher standards and greater capital reserves.
I think some learning has been done and there is genuine concern at high levels.

by blobbles | 24th May 19, 10:25pm 1558693508

Wait, was this the same crowd who told us that the FBB would have no effect?