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The rules for residential property deductions have changed - find out how they might affect you and your properties

From the 2019-20 income year onward, new rules apply to deductions claimed for residential properties. Residential property deductions will now be ring-fenced, meaning that they can only be used to offset income from residential property.

This means that the residential property deductions you claim for the year cannot exceed the amount of income you earn from the property for the year. Any excess deductions must be carried forward from year to year until they can be used. You cannot use excess deductions from your residential property to reduce your other income, such as salary and wages or business income, which would result in a reduced tax liability.

If you have more than one property, you can choose to apply these rules on a portfolio basis or on a property-by-property basis. You can find more information on these rules below, or in the Tax Information Bulletin, Vol 31, No 8 - September 2019, from page 53.

Tax Information Bulletin - Vol 31, No 8 - September 2019

How to file your IR3 return if you have residential property deductions Video information

Portfolio basis

The portfolio basis is the default basis for handling residential rental income deductions. Under this basis, the ring-fencing rules are applied to all of your affected properties as a single portfolio in each tax year. This means that the allowable deductions for the properties in your portfolio can be offset against income you earn from all of the properties in the portfolio. Any excess deductions from the portfolio overall can be carried forward to future years.

Property-by-property basis

The deductions for each property dealt with on the property-by-property basis can only be offset against the income from that property. Any excess deductions must be calculated and carried forward for each property individually. If you use this basis, you'll need to keep accurate records to show that the deductions for each property were only claimed against the income from that property.

If you want to use the property-by-property basis for a property, you need to take a tax position consistent with this basis in the tax return for the later of:

  • the 2019-20 income year
  • the income tax year in which you first start using the property for residential rental income.

The property-by-property basis continues to apply as long as you keep filing tax returns consistent with this basis.

If you have two or more properties, you can choose to use the portfolio basis for some and the property-by-property basis for others.

We recommend that you talk to your tax agent about which approach is best for you.

There are some residential properties that aren't affected by the ring-fencing rules, including:

  • your main home (if you have more than one home, this is the home you have the greatest connection with)
  • property that comes under the mixed-use asset rules
  • farmland
  • property used mainly as business premises
  • property you've identified to us as land that will be taxed on sale, regardless of when it's sold
  • property owned by companies (other than close companies)
  • employee accommodation
  • property owned by Government enterprises

If you're unsure if a property is affected by these rules or not, we recommend you talk to your tax agent.

If you have a tailored tax code (previously known as a special tax code) or certificate of exemption for rental losses, you may have a tax bill at the end of the income year. You will have until 7 February 2021 to pay, with standard late-filing penalties and interest apply after this date.

If your tailored tax code relates specifically to rental losses, you will need to contact us to discuss your situation and avoid further debt. You can either cancel your current tailored tax code and complete a new Tax code declaration - IR330 or amend the current tailored tax code to a higher rate to cover the reduction already received. Payment plans for the 2021 payment deadline will also be available.

Tax codes for individuals

Most rental properties are not subject to tax when they're sold. If the sale of your property is not taxed, any excess deductions you have will continue to be carried forward. They'll be able to be used against any residential income you may have in future years.

If the sale of your residential property is taxed (for example, if you sell your rental property within the bright-line period), you can use your accumulated excess deductions against the net income from the sale. If you still have unused excess deductions left after that, they may only be used to offset other income like salary and wages if either:

  • you used the property-by property-basis for the property
  • the property was part of a portfolio, you've sold all of the portfolio properties, and all of the sales were taxed.

The amount that may be released in these situations will depend on whether you have excess deductions transferred from another property that was not taxed on sale.

More information on how these rules apply to a taxable sale of residential property is available in the Tax Information Bulletin, Volume 31. For further help, talk to your tax agent.

Tax Information Bulletin Volume 31

The residential property deduction rules (also known as ring-fencing rules) mean that when you complete your 2019-20 income tax return, your total residential rental property deductions generally cannot be more than your residential property income. If you have excess deductions (also known as rental losses) the amount must be carried forward to the next year that you earn income from your residential property or transferred to another residential property. If you own more than one residential rental property and you’ve decided it works for you to have them in a portfolio you can combine their income and deductions.

Most residential properties are subject to the new rules. The rules do not apply to some residential properties such as your main home and residential properties that are subject to the mixed-use asset rules.

Residential rental property deductions

You will now enter the residential rental information in the “Residential property” section of your income tax return. If you use myIR to complete your return both the “Residential rental income” and “Other Rental Income” boxes are pre-selected. These cannot be unticked.

“Residential Rental income” is for residential rental properties and “Other Rental income” is for commercial properties, your main home and mixed used assets, where a loss can still be claimed. If you do not have other rental income, leave the “Other Rental” income fields as nil. If you do have other rental income (property that does not fall into the ring-fencing criteria) then complete those fields as normal.

We encourage you to use the Residential property deductions worksheet - IR1226 to help you work out the amounts and where to enter the amounts in your income tax return. We also encourage you to use the Rental income guide - IR264 and the relevant income tax return guide.

If you're filing a Partnerships and look-through companies income tax return - IR7, the net residential income or losses are not reported there.

Completing an IR7 and allocating rental income to an IR3

Only the total residential income and deductions for a partnership or look-through company are entered on the Partnerships or look-through companies income tax return - IR7. The amounts are allocated to each partner or owner's Individual tax return - IR3 where the net profit or loss is worked out with any other rental income or deductions they may have.

Completing the IR7
  • Enter the total:
    • income from residential rentals in the "Total residential income" field (box 18B) - do nor enter a negative amount as it will cause an error
    • deductions in the "Residential rental deductions" field.  
  • Do not include the "Residential rental deductions" (box 18C) amount in the "Total income/loss" field (box 22) or "Total income/loss after expenses" field (box 24) - the allowable deductions are worked out on your IR3.
  • Allocate the amount in "Total residential income" (box 18B) and "Residential rental deductions" (box 18C) between each partner or owner by completing  the "Total residential income" (box 26G) and "Residential rental deductions" (box 26M) in a Partnership income/loss attribution - IR7P or Look-through company income/loss distribution - IR7L form for each partner or owner.
  • The amount in the "Total income/loss after expenses"(box 24) filed on the IR7  must be the same as the total of all amounts allocated from each of the "Total income" (box 26K) fields on the IR7P or IR7L forms.

If you include a Rental income schedule - IR3R with your IR7, be aware that the net profit or loss does not populate on the IR7 or on each partner or owner's return. They'll need to work these amounts out themselves.

When completing your IR3, add the amounts from "Total residential income" (box 26G) and "Residential rental deductions"  (box 26M) fields from your IR7P or IR7L to any other residential income or deductions you have before working out the net profit or loss. Use the Residential property deductions worksheet - IR1226 to help work out your net rental income or loss.

We have more information about residential rental property deductions.

Residential rental property deductions

If you have a child support assessment, you may need to re-estimate your income following these changes.

Estimate your income for a child support assessment

If you have a tax agent, you may like to ask how these new rules affect you.

For any further questions, you can contact us