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Rental Property Income – Ring fencing of deductions

Starting income year 2019-20, a legislative change has been implemented towards the way expense deductions can be claimed for a rental property. Any excess deduction over and above the income cannot be set off against other taxable income, such as salary or wages. It has to be carried forward as a separate loss portion to be set off only against future rental property income.

The change is aimed at levelling the playing field for home-buyers and owner-occupiers versus property investors, who hold on to property investments for non-taxable capital gain, while reducing tax liability on yearly income by setting off the rental losses.

The definition of property for the purpose is the same as for bright-line test, being a residential land (land holding or having an arrangement to hold a dwelling). It specifically includes overseas residential land as well. Exclusions are such land that are farmlands or used predominantly for business. The rules also do not apply to certain other specific properties, such as the taxpayer’s main home, property used for both business and personal (mixed) use, property subject to tax on sale, or is held by companies other than closely held companies. The focus is purely on loss-making rental properties, and mixed-use assets are already ring fenced for the business portion.

The rules can be applied on a portfolio (by default) or property-by-property  basis, as opted for at the start of the financial year 2019-20 or the first year in which the property becomes a residential rental property. The selection should be based on the overall profitability of each property or the portfolio, and can be changed in a future year.

It should be kept in mind that if any particular property in a portfolio is taxable on sale, the rental loss from that property can be set off against other income only if it is accounted for on property-by-property basis and not portfolio basis. If a taxpayer has made an overall loss in a particular income year but has made a profit on the residential rental activity, any ringfenced residential property deductions they have from prior years would be able to be used against those profits. Also, the unused ring-fenced deductions can be carried forward even if the property itself has been sold.

The shareholder of an LTC can use their share of deduction against their own rental property income if the LTC has opted for the portfolio basis and has made an overall loss. The carry forward is subject to shareholder continuity rules, and is treated the same as unused tax loss. Also, the interposed entity rules apply, which means any interest for loan taken to purchase shares in a company of which more than 50% of the assets are residential land, will be subject to ring fencing. This means the interest claimable is restricted to the proportion of the value of residential land within the overall assets.


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