Ring Fencing Tax Losses 101 - Don't Panic

by Nick Gentle on Jan 28, 2019
Article appears under: Accounting and Tax, About Property Investment, Investment Strategy, Mortgages, The Numbers, Your Expert Team

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The Labour-led coalition has moved forward with ring-fencing tax losses on an investment property (or investment property portfolio). 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.

My first point has to be that your tax losses will accrue and when your portfolio tips into an annual profit, you will enjoy a tax-free period. You don't lose the benefit, it is merely deferred.

More than that, I would like to instead focus on just what this means in the wild, so I pulled out my property calculator and ran some actual numbers.

Price and Rent

• Purchase Price: $500,000 
• Assume No Deposit
• Rent: $500 per week
• Annual Rent (50 weeks): $25,000

Annual Costs 

• Rates: $2,000
• Insurance: $1,500
• Property Management: 8.5% including GST
• Maintenance: 5% of rent
• Interest: 4.5%

• Annual Loss: $4,375 or approx $84 per week

Until now (taking a general tax rate) you would have claimed back approx 30% of the loss, so $1,312.50 or $25.24 per week.

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 probably come out ahead in the process).

Make sure you are at market rent

I hate to break it to you but you can't increase to $525 per week just because you want to. If all other properties are $470-$500 per week you will struggle to rent yours.

But if you have for years kept your property "just below market rent" then it's time to stop that and charge fair value for the use of your asset. 

Many landlords don't charge what their property is worth because they are afraid their tenants will leave. If this is you then it is time to realize there aren't many areas in New Zealand that are short on housing.

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 continue to increase

Rents tend to increase in line with inflation as well as supply and demand. Keep these facts in mind...

1. Minimum wages will increase, which will flow over into a pay bump for many others, which increases costs, which means inflation and pressure on rents.
2. 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 $500 per week now, I would not be surprised if the market increased by at least the $25 per week shortfall within a couple of years even if you do nothing else.

Do your Repairs and Maintenance (R&M) by March 31, 2019

If you have any big-ticket repairs coming up, this current financial year is the time to do them, before the new rules come into effect. 

Understand what the R&M Budget actually is

Most investors set aside money for repairs, however your R&M budget of $2,000 doesn’t mean you spend $2,000 per year. You may spend very little for many years and then replace a bathroom or a repaint.

If your property is in good condition now, you should expect a few years of gradual rent increases before you need to spend any large amounts. 

In saying that, it is best to get on top of maintenance while problems are small and cheap to fix.

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 you are borrowing at 5% to earn 10%.

Review your Mortgages and Insurances (the biggie)

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:

• 60% on 3-5 years lending (to avoid shocks)
• 30% on 1-year lending (best rates)
• 10% on revolving credit (this is increasing as money builds up)

Negotiating a slightly better rate, moving some debt to a shorter (cheaper) term rate or negotiating a cash-back reward 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 me $100 per week. Easily more than this rule change would cost me if I owned this property.

Another option if you pay principal and interest and really need to improve cashflow is to change a portion of your debt to interest only (IO) for a while. Again, get proper advice and think things through because banks are less willing to allow investors to roll IO loans over in perpetuity. 

Did you just pick your insurer out of the Yellow Pages years ago? 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.

Pay down some principal or leverage offset loans

Reducing your interest-bearing debt, either by paying down principal (or these days, by putting cash into a revolving credit loan) is a time-proven way to lower your risk and increase net cashflow. I love offset loans, they give me the benefit of lower interest costs without giving up the flexibility of ready cash. 

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? Fixed-term leases are a great way to avoid vacancies and 2 extra weeks of rent means $500 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. Just last week I paid my accountant for a one-hour session to go over some ideas I have. The tax savings we talked about blow the cost out of the water.

Offset with a Cashflow Positive Property (another biggie)

Property Investment is a portfolio game and making a profit tends to scale better than losing money. It is very common for investors to balance their portfolio with higher cashflow deals, if not focus entirely on that strategy from the get-go.

If you do not know how to safely buy cashflow property or feel that you would need to look in new markets then please consider our buyers agency service, helping investors buy with confidence in any market is what we do.

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 new world out there where investing makes you money.

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 inspection, rental appraisal and mortgage advice.

Summary - Take the time to work through it

The market changes and investors need to change with it. IF you have a cashflow negative portfolio it's time to slow down and think things through and try to visualize what your portfolio will or could look like a few short years into the future before jumping to conclusions.

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 reason 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 maths 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.

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