Inland Revenue have released the September 2019 Tax Information Bulletin (TIB), which clarifies this.
For the purposes of this blog post, we are going to assume that the LTC or an individual only holds residential rental property i.e. no commercial, they are not a trader or an associated person or a developer etc, they don't have an Airbnb-style short-stay accommodation house in the picture.
Can losses from an LTC with residential rental property be offset against income from rentals owned by a partnership or in your personal name?
It depends on whether
However, the answer is essentially, "Yes", if:
So the result is, you can have a negatively-geared LTC, and given the above points, the losses can flow through to you as a shareholder. You can then offset this against profits from a personally-owned rental (either solely owned or in a partnership). The situation also works in reverse ie there are profits in the LTC and losses in the personal/partnership rental.
Note that you can't offset any losses against income from other sources e.g. wages, like you used to in the good old days. That is what the concept of "ring-fencing of losses" means. The losses are "ring-fenced" so that they only apply to residential rental property.
Some interesting points
Do restructure strategies such as selling your old family home to an LTC still work?
We have previously recommended this, in blog posts such as this one. The answer is that yes, the rules are unchanged, and this still effectively meets IRD requirements for interest deductibility and remains a good strategy.
However, just be aware that any losses are ring-fenced, as described above. For more info, the IRD Sept 2019 TIB is below
As always, situations vary, so please contact us for advice on your specific situation. Call 099730706 or email us here
You've established that there are good economic reasons for changing the shareholding in your LTC that owns rental residential property. You and your life partner are the shareholders. What things do you need to consider so that you don't get hit with a nasty (and unexpected) tax bill?
1. Brightline Test
2. Shareholders Current Account
Let's say that the company owes the shareholders $150,000. This is tracked in the Shareholders Current Account, and is a liability (debt) of the LTC.
Bob has 99 shares, and Mary has 1. Bob will sell/transfer 49 of his shares to Mary so that they each have 50 shares. Let’s say at the moment, Bob and Mary are owed $75,000 each by the company.
The LTC has made losses so is technically “insolvent”. The ramification of this is that as 49% of the shares are transferred there is a deemed disposal of 49% of the both advances being a total of $73,500 at a market value of zero (due to the company being insolvent).
Under special tax rules the $73,500 is initially deemed to be income of the LTC to be taxed to the owners in proportion to their shareholding (Bob $72,765 and Mary $235). Under recently-amended income tax rules, this income will not be taxed to the extent it is in proportion to shareholding. In this example Bob has debt of 50% for a shareholding of 99% and Mary has debt of 50% for a shareholding of 1%. Under the new rules he will be taxed on 49% of the debt being $73,500 and Mary will not have taxable income.
In this scenario, the de minimis* threshold of $50,000 would be exceeded when Bob transfers his shares (as the deemed income is $73,500). This same issue arises when either the LTC status is revoked or the company is wound up.
Going forward, ideally all LTC shareholder debt should be in proportion to shareholding. Between family members this can be achieved by way of an assignment of debt as that is another way of presenting what is happening. Then going forward debt should be transferred along with shareholding so the debt stays in proportion.
3. Depreciable Assets With Costs Over $200,000?
Is the cost of any of the LTC’s depreciable assets more than $200,000 each? If so, you then need to ask: Is the value of the accumulated depreciation on assets per shareholder more than $50,000 (the "de minimis" threshold)? If so, then there could be tax implications.
Please contact us for advice. You may also want to read this related blog article "Are Tax Benefits a Good Reason to Make Changes?"
* "de minimis" is a Latin expression meaning about minimal things, normally in the locutions de minimis non curat praetor ("The praetor does not concern himself with trifles") or de minimis non curat lex ("The law does not concern itself with trifles") a legal doctrine by which a court refuses to consider trifling matters.
You and your significant other each own 50% of the shares in an LTC. It owns negatively-geared rental property. At tax time, you get your 50% share of the loss, which generates a nice tax refund.*
Previously you both earned about the same, but now there is a child in the mix, and one of you is working less as a result, and earning less as a result.
Suddenly that 50/50 company shareholding doesn't look so good. Should you change it to 99/1 to get better tax refunds?
The short answer is no. If you do anything with the motive to purely pay less tax, then you leave yourself open to being accused of tax avoidance.
What to do then? Well, there may well be economic reasons for the change, which had not previously been considered. When you take these into account, any so-called tax benefits could well become purely incidental.
As each situation is different, it's not practical to outline these here, so please feel free to contact us to discuss.
You may also wish to read a related article: Changing Shares in LTCs: Considerations
What is the NZCO?
NZCO is short for New Zealand Companies Office.It is part of MBIE (Ministry of Business, Innovation and Employment) and administers a number of registers, including a register of companies, their directors and shareholders, and related documents.
What's a Companies Office Return?
All companies are required by the Companies Act 1993 to file an annual return with the Companies Office regardless of whether or not they are trading.
If an annual return is not filed by the due date, the company risks being removed from the register as the Registrar may be satisfied that the company has ceased to carry on business.
An annual Companies Office return is not a tax return, it's simply an annual requirement for a company to provide certain details to the Companies Office.
For more details, see this page at the Companies Office.
Does EpsomTax.com Handle This For Me?
We certainly do. At this time, we don't charge for filing your annual Companies Office return. Most accountants charge $80-$100 + GST, but we don't. Honestly, it only takes a minute or two so we don't feel we can justify charging for it.
We also offer an optional compliance package, which we'll contact you about at the same time. Questions? Please contact us.
MUST WE Have an Annual Meeting?
Yes, it is a requirement for all NZ companies. But don't despair! It's a great chance to go out for dinner on the company. Keep your receipts for the meal, drinks, taxi, babysitter. While you're out (or shortly thereafter), make sure to complete this annual meeting form, which will be sent to us when you click Submit. You can even attach your receipts to it!
As always, if you are not sure or need more information, please don't hesitate to contact us.
That's a good question. What is a Look Through Company or LTC?
Basically, it's the replacement for the old LAQC (Loss Attributing Qualifying Company). At tax time, you look through the company to the shareholders, and distribute the income (or losses) to them.
How is it different from a normal company then?
A "normal" limited liability company can pay dividends and pay salary to its shareholders. Whatever is left after that is what it pays tax on. A LTC distributes all the profit (or loss) to the shareholders. It's more like a partnership, but with a limited company wrapped around it.
How do you figure out who gets what?
The income distribution is based on the shareholding. So if you have a 90% shareholder and a 10% shareholder, then the 90% shareholder gets 90% of the profits/(loss) and the 10% shareholder gets 10%.
So, what's the point of that?
Many people use LTCs to own their residential rental investment property. A common strategy that financial advisors recommend is to purchase negatively-geared rental property (negative gearing means that the expenses are more than the income). The shareholders have to top up the mortgage with their own money, often $50-$100/week. The LTC then has losses at the end of the financial year. These losses are then distributed to the shareholders. This, in turn, historically had generated tax refunds, which helped pay for the property.*
Can you give me an example?
Sure. Mr Smith earns $130,000 per year before tax. Mrs Smith isn't working. They set up a LTC and it purchases a negatively-geared rental property. They put about $125 a week into the LTC to help pay the mortgage. Mr Smith has 99% of the shares, and his wife the remaining 1%. At financial year end (31 March), there are losses of about $20,000. Mr Smith gets 99% of these to offset against his wages. The formula is
Wages - LTC losses = net income
In this case, it would be
$130,000 - $19,800 = $110,200.
Mr Smith paid $33,820 in PAYE tax, based on his salary of $130,000. However, the tax on his adjusted income is $27,286. So he has overpaid his tax by $6,534. This amount is paid back to him as a tax refund.* As this averages out to $125/week, this effectively pays for their mortgage top ups.
See this article for more info and examples of how losses work.
How is this different from a partnership?
Another good question. See this article for an explanation.
I'm convinced. How do I get a Look Through Company setup?
Simple! Fill in the form here and click Submit. We'll send you an invoice, and within 2-3 working days your company should be incorporated. Easy and painless.
I've got a few more questions. Can I talk to somebody?
Sure. Contact us today.
That's a good question, and it depends a lot on what entity incurs the loss. Let's break down the various types and what effect they have.
Look-Through Company (LTC)
If you are a shareholder in a Look-Through Company (LTC) and that company makes a loss, then you get to carry that loss through to your personal tax return (usually an IR3). There are a few rules and limitations* which we won't go into at length here.
Let's assume you're a salaried employee, and so you've had PAYE deducted from your wages. Well, at the end of the financial year a wash-up is done on your personal tax return. The above-mentioned loss is deducted from your gross (pre-tax) wages. It might look something like this:
-$ 5,000 Loss from LTC
- - - - - - -
$80,000 Net taxable income
We then calculate (a) how much tax you have paid, and (b) how much tax you should have paid. If (a) is more than (b) then you get a tax refund. If the other way around, you have tax to pay.
Limited Liability Company (LLC)
Ok this situation is totally different. If the LLC makes a loss, then it can't be passed on to anyone. Not the shareholders, not the directors: no one.
Instead, it carries that loss forward to the following financial year. If there is taxable profit, then the loss can be offset against that profit. It might look something like this:
$85,000 Net taxable profit
-$ 5,000 Losses brought forward from previous years
- - - - - - -
$80,000 Net taxable income
If there is no profit, then you just keep carrying the losses forward, year to year.
If you have a trust it's the same as an LLC with respect to losses. They can't be distributed out to the beneficiaries. Rather, they get carried forward until there is profit to offset them against.
A partnership works in a similar way to a Look-Through Company essentially. Losses are distributed to each partner, according to the rules of the partnership.
Sometimes you might combine some of these structures.
For example, a trust might own all the shares in a Look-Through Company. The LTC makes a loss. What happens then? In this case, the losses flow through to the Trust. They are then dealt with as explained above.
In the meantime, please contact us with any questions, or talk to your tax professional.
* From 1 April 2019, tax losses will no longer flow through from LTCs that are residential land rich. Please see us or call for advice on how to get the best results from your portfolio, build wealth and minimise tax
Also known as: How do you make an LTC election?
It's reasonably straight-forward. Once the company is incorporated (click here if you want us to do this for you), you then complete and send off an IR862:
Section 1 is fairly self-explanatory, although you may come unstuck at the part where it asks you to choose the income year. Accountants always refer to the financial year as the one ending next March. For example, if today is the 31st of March 2015, then we are in the 2015 financial year. However, if today was the 1st of April 2015, then we would be in the 2016 financial year. So make sure you put the right financial year on the form!
In Section 2 you repeat some of the information from Section 1, and then fill in the details of the Owners. The bits you need to fill in are:
then sign and date the form.
Send this to us, or post it directly to:
PO Box 39010
Wellington Mail Centre
Lower Hutt 5045
Make sure you read the instructions on the back, as you can only have a maximum of 5 Owners.
The other thing we'd usually get you to do is complete a resolution, assuming you are purchasing property. Download our sample resolution below for free.
Excellent question. Let's assume you have
What do you want to achieve? In order of priority:
Don't panic! We can help.
So, how should you structure things to obtain this
no. 1 objective as fast as possible?
Why You Should Pay Off the Mortgage on the Family Home First?
Now, at this point you may be wondering why you should do that. Well, it comes down to "good debt vs. bad debt." What do we mean by that?
This is tax-deductible debt. Debt on your rental property is tax-deductible. So it is "good" debt in that it is working for you.
Debt on your family home is not tax-deductible (although if you run a business from home then a small portion will be), so it does nothing for you. It is "bad" debt from this point of view.
So, logically, you want to drive down the "bad" non-deductible debt as soon as possible, and give this priority over debt that is working for you
How Should I structure my mortgages?
Here are our six key recommendations:
Can EpsomTax.com organise that for me?
No. That's what a mortgage advisor does. We recommend that you have a talk to Velocity Financial.
What's the benefit of selling my rental to an LTC?
There are numerous benefits, but one key one is that it allows you to increase good debt and decrease bad debt. This is because you can sell the rental to the LTC at market value (you'll need a registered valuation), and then adjust the mortgage upwards on the LTC in line with that value, and readjust the mortgage downwards on your own home. The end result is that the total mortgage amounts are the same, but you've now in effect turned a lot of bad debt into good debt. Note that in some circumstances you can simply revalue without needing to set up an LTC. Talk to us about your options.
I want to buy a better family home or upgrade it. Is that borrowing tax-deductible?
No. For interest on loans to be tax-deductible there has to be a business purpose. However, if structured correctly, then extra funds can be raised for a business purpose. Again, talk to us about this.
What do I do after I've paid off my family home?
Well, even before you've paid that off completely you have options. You might be surprised at how soon you have equity in your family home and in your rental. This allows you to leverage into another property. However, you are best to get advice from an Authorised Financial Advisor about this. They are the only ones who are licensed to give you specific financial advice. Contact us for more information.
Is an LTC the right structure for my rental investment property?
Probably. Watch this short video, then call us to discuss your specifics on 0800 890 132.
Do you have any other information on this stuff?
Yes, check out our FAQ page and also these blog articles
If you've got 5 minutes, make yourself a hot cuppa and enjoy this video presentation by Garreth Collard, Principal of EpsomTax.com in which he addresses APIA members on the pros and cons of the most common Rental Ownership Structures. Click here for a copy of the handout being used at the presentation.
See this insightful 3-minute video presentation by Garreth Collard, Principal of EpsomTax.com in which he explains the nuts and bolts of the most common rental ownership structures to APIA members. Click here for a copy of the handout being used at the presentation.
Disclosures: EpsomTax.com does not claim endorsement by APIA. Garreth Collard was invited to speak to APIA members by APIA. Garreth was not remunerated for this.
Note: Some partnership agreements do allow annual adjustments to distribution of losses/profits; check the wording of your agreement with your lawyer if you are not sure.
Accounting for your rental residential investment property; specialised property tax advice. Buy me a coffee!