Ring Fencing Tax Losses 101 - Don't Panic
The Labour-led coalition has moved forward with ring-fencing tax losses on an investment property, either to the property itself OR to the owning entity (to be confirmed). So investors will no longer be able to offset those losses against other forms of income, namely salary income.
As expected, the reaction from investors has been just a tad negative, with many questioning why property investment should get singled out as a business type.
I'd like to instead focus on just what this means in the wild, so I pulled out my pen and a napkin to scribble on, and ran the numbers on a hypothetical slightly cashflow negative property:
- Purchase Price: $400,000
- Assume No Deposit
- Rent: $400 per week
- Annual Rent (50 weeks): $20,000
- Rates: $2,000
- Insurance: $1,000
- Property Management: $1,600
- Maintenance: $2,000
- Interest: 4.5%
- Annual Interest: $18,000
- Annual Loss: $4,600 or approx $88 per week
Until now (taking a general tax rate) you would have claimed back approx 30% of the loss, so $1,380 or $26.50 per week.
Well that feels better than headlines like "XYZ is being BANNED". Now, where can you get back $25 per week?
First of all, it is being phased in over 5 years so it’s more like $5 per week you need to make up in year one… but I’ll stick with $25.
I'm sure you know where I'm going with this... there are a ton of ways you can look to make back that $25 and more.
Check your Rents Today
I hate to break it to you but you can't increase to $425 per week because you feel like it, if all other properties are $400 per week you will struggle to rent yours.
However, many landlords, particularly those who self-manage, charge under-market rent. A common reason is they are afraid their tenants will leave. If you are beneath market rent it is time to realise that there are a lot of good tenants looking for homes, so check out current rents on TradeMe and start to get on top of things.
If your property is on a fixed-term lease, talk to your property manager about what rents are expected to be when it comes up for renewal again and if there are any small improvements you could make to increase the rental return.
Rents Will Almost Certainly Increase
Rents tend to increase inline with inflation as well as supply and demand so you should be aware of two facts:
- We are not far away from a minimum wage increase, which will flow over into a pay bump for many others, which increases costs, which means inflation and pressure on rents.
- The supply and demand statistics still show a massive shortfall of housing in most areas and this is not going to change soon.
If your property achieves $400 per week now, I would not be surprised if the market increased by at least the $25 per week shortfall relatively soon just on it’s own. Remember this is being phased in over 5 years, so a tiny $10 increase per year means you're covered with room to spare.
Be Smart With Maintenance...
Most investors set aside money for repairs but of course a R&M budget of $2,000 doesn’t mean $2,000 per year, it means not much for many years and then a new bathroom or a repaint. It is best to get on top of maintenance while problems are small and cheap to fix and within reason you can probably defer maintenance for a few years until your rents have increased a bit.
... However Proactive, Can you Add Value and Increase Rent?
Those of you with property managers, use their expertise! Find out what improvements you could make that would increase rent. A new carpet, paint and spruce up might cost you $10,000 but if it increases your rent by $20 per week, that is a 10% return on your investment and even if you borrowed the $10,000 you would be better off by $10 per week because of it.
Review your Mortgages and Insurances
For almost all property investors, mortgage interest is your biggest cost. Sit down with your mortgage advisor and make sure you are optimally structured. Here is my approximate structure for example:
- 75% on 3-5 years lending (to avoid shocks)
- 20% on 1 year lending (best rates)
- 5% on revolving credit (this grows as money builds up)
- Negotiating a slightly better rate or moving some debt to a shorter (cheaper) term rate could save you more than $25 per week easily. I used to have more of my debt in the 5 year range and by moving to a shorter tenor it I saved I think $100 per week.
Another option for those who pay down principal on their mortgages and really need to improve cashflow is to change a portion of their debt to interest only for a while. Again, get proper advice and think things through.
Call an insurance broker and get all of your risk reviewed. Are you with the right insurance, are there better options available? Are you over-insured (or under)? Where are your excesses set? I have a bit of a higher excess on my properties than many, it probably saves me $500 per year. I’m more worried about a rebuild than a leaky tap. Your risk profile might be different.
Review your Rent Strategy
I'll put AirBNB to one side because that is a whole different ball game, but are you better off with a 12-month fixed leases over periodic tenancies? 12 month leases are a great way to avoid vacancies and 2 extra weeks of rent means $800 or an average of $15 per week.
Review your Entity Structure
Are you paying a lot each year to maintain a complex setup when something simpler would work just as well? A periodic review with a property specialist accountant is well worth the one-time hourly fee and could save you thousands over time.
For long-term investors, you will still get the tax breaks
As your property shifts to cashflow positive over time, accrued losses will be usable to reduce your tax bill. It just takes a bit longer than now.
Offset with a Cashflow Positive Property
Property Investment is a portfolio game and it is very common for investors to balance their portfolio out with a mix of location "growth" properties and cashflow deals. Maybe all you need to do is re-tool where your capital is allocated and keep on keeping on.
Buy Well and Get Good Advice
Lost in all the political noise is the fact that if your property is cashflow positive or neutral, it's business as usual. If you were looking at property and believe that because properties "all lose cashflow" each week you should look elsewhere then I invite you to please get in touch with us because there's a whole 'nother world out there my friends.
It is important to know exactly what you are buying when you invest in a property, understand how the numbers work, have a vision for where each investment will take you and to get the right entity, insurance, building spection, rental appraisal and mortgage advice.
Summary - Take your Time
What I'm trying to say is that the market changes, and we as investors need to change with it. IF you have some cashflow negative property, work through all of your options. It's time to slow down and think things through and try to visualise what your portfolio will or could look like a few short years into the future before taking action today. .
Remember, if you are in for the long term, you will have a period of tax-free income as the losses get offset in the future. The decision to sell should come last and not first.
It is worth going through the above list every year or two, however the government policy change just gave you a very good reminder to do so now. If you'd like an introduction to an accountant, mortgage broker or insurance advisor please just email me at the address below.
Disclaimer/Disclosure: While I am a big optimist about the future of NZ Inc. I am NOT an accountant or financial advisor and these numbers are back-of-an-envelope stuff and are not intended as financial advice. Please do your own math and get a professional to check things for you.
If you have any questions or thoughts on this topic please get in touch with me, I would love to hear them.
Business Owner & Operations Manager