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Ring Fencing Options

21 August 2019

 

Ring Fencing Options


As many of you will know, Ring Fencing has come into effect from 1/4/19.
 
In general, this means if you have losses from Property Investment, you will not be able to offset these losses against other income.  Resulting in no tax refunds.  There are some exemptions I have covered in other blogs, and also watch out for our video coming up.
 
Under the new Ring Fencing legislation, there are two options:
 
1)  Portfolio
2)  Property by Property.
 
The default option is Portfolio and in most cases this will be the option used by most investors.
 
With the Portfolio method, the losses from one property can offset the profit from another.  IMPORTANT to be careful that your structure allows such an offset.  For example, if the loss rental was in a Trust, and the profit rental was in your personal name, normal tax rules would not allow an offset.
 
Example with Portfolio:

  • You have 3 rentals:

-  2 make a profit, combined $9,000

-  1 makes a loss, $5,000

  • If in correct tax structure, you would only pay tax on the $4,000 overall profit.

 
Property by Property means you keep each property separate.  If a property makes a loss, this loss would carry forward within that property and could only offset future profits from this property.  If you also had a profitable property, under this option you would have to pay tax on the profit and couldn’t offset against the loss property.
 
Example with Property by Property:

  • You have 3 rentals:

-  2 make a profit, combined $9,000, Property A and B

-  1 makes a loss, $5,000, Property C

  • You would pay tax on the $9,000 profits from A and B
  • The $5,000 loss would carry forward from Property C and could offset future profits from Property C.

 
 
SO WHY WOULD YOU USE PROPERTY BY PROPERTY?
 
There would only be an advantage in very limited situations!  If a property is sold and its gains were taxable (Brightline, subdivision rules, rezoning, tainted sale, etc, Depreciation recovery doesn’t count!), then in certain cases those losses can be released and offset other income.
 
Property by Property example of Advantage

  • Rental Property purchased 1/4/19 $500,000
  • LTC with Joe as shareholder.
  • Losses

-  First year $10,000

-  Second year $15,000

-  Third year $20,000

-  Fourth year $20,000

-  Overall $65,000

  • Rental Property sold 1/4/23, 4 years later $505,000 after costs
  • Brightline rules, the $5,000 gain is taxable
  • $65,000 losses carried forward, can offset the $5,000 Brightline gain, leaves $60,000 losses.


As no other properties, the $60,000 is released and this loss can offset other income!  Note still need a tax structure that allows these losses to be used.  In the example, $60,000 loss would flow to Joe as shareholder, and then could offset Joe's salary.  If Joe earning over $70,000 would save tax at 33%, so save approximately $20,000 in tax!



BUT HOW FAR FETCHED IS THIS?

A)  $65,000 losses over 4 years is huge.
B)  What is the likelihood of only $5,000 gain from tax from Brightline, subdivision, or other tax rules?  If the property was sold for $575,000 after costs, then would be $75,000 taxable income under Brightline rules, which would use up all the $65,000 losses, so NO losses would be left!  So no advantage!
 
 
 
Portfolio example of disadvantage 
 
It will be extremely hard for any losses left to be released and able to offset other income.
 

  • You have 3 rentals:

-  Property A makes the $65,000 loss, the same as Property by Property example, over 4 years

-  2 rentals break even over the 4 years, Property B and C

-  LTC with Joe as the shareholder

  • Property A cost $500,000
  • Property A is sold 4 years later for $505,000 after costs
  • Brightline rules, the $5,000 gain is taxable
  • $65,000 losses carried forward, can offset the $5,000 brightline gain, leaves $60,000 losses
  • The $60,000 losses would carry forward within the Rental Property Portfolio and could offset future property profits.

 


DISADVANTAGE OF PORTFOLIO

  • To get the $60,000 losses released, so that could offset other income
  • Need to sell all properties in a taxable event.  So need to sell Property B and C within Brightline period, or caught for tax under subdivision rules or a similar provision.

 
 It would be extremely unlikely that if all three long term hold rental properties were sold , that all three would be taxable.  If either property A or B were not taxable sales, then $60,000 loss would stay ring fenced and could offset future property profits, but not other income.  Also, if Property A and B sales were taxable, it is likely that all $60,000 of losses would have been used up to offset those profits, so nothing would be left to offset other income.
 
 

 
 One Example where Property by Property would make sense
 
If you purchased a rental that was making large losses, like the $65,000 example over 4 years.  And you sold the rental at a loss within the 5 years (tax under Brightline rules).  Then Property by Property would allow you to access the losses and offset against other income.
 
I hope you are not planning on either having huge losses, or selling within 5 years or selling at a loss.  So hopefully this option isn’t that appealing.
 

 
PROPERTY BY PROPERTY - Runs the risk of paying tax on income, while having losses you can’t use.  Plus will incur extra compliance costs.
 


OVERALL

  • If you have owned all of your rentals for more than 10 years, then unlikely to be taxed.  So, Portfolio is the obvious choice to keep things simple.
  • If you have all profitable rentals - then Portfolio makes sense.  Would be worth reviewing your structure with me, and also make sure you watch the video we are planning to release next week for a common idea.
  • If you have some profitable rentals and also some rentals making a loss - then worth having a chat with me to check your structure is right.  Also watch our video next week.
  • You have a rental that is likely to make a large loss - then worth having a chat with me as Property by Property could be appropriate.

 
Kind regards
Ross Barnett

 
 
 
 

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