WHAT HAPPENS IF YOU MAKE A TAX LOSS NZ?

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). IRD’s LTC guide (IR879) says the company itself isn’t liable for income tax. Its owners include their share of its income and deductions in their own returns. They can use its losses against their other income.

Let’s assume you’re a salaried employee, and so you’ve had PAYE deducted from your wages. 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:

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 it’s the other way around, you have tax to pay.

Worked Example 1: Fiona’s LTC Loss

Fiona earns $85,000 in wages as an employee. She also owns 100% of an LTC that runs a small catering business. The LTC makes a $5,000 loss. The business isn’t rental property, so the loss flows through to Fiona.

IRD’s individual tax rates set the tax on each figure:

• Tax on $85,000 is $15,650.50 on the first $78,100, plus 33% on the remaining $6,900 ($2,277). That is $17,927.50.
• Tax on $80,000 is $15,650.50 on the first $78,100, plus 33% on the remaining $1,900 ($627). That is $16,277.50.

The difference is $1,650, which is Fiona’s refund. It equals $5,000 × 33%, because the loss comes off the top of her income. This example ignores ACC levies and any other income.

What Are the Rules and Limitations?

There are a few rules and limitations on LTC losses. These are the main ones:

• Ring-fencing. Residential rental losses can’t reduce your other income. We cover this in the next section.
• Loss limitation. IR879 says the old loss limitation rule was removed for most LTCs from the 2017-18 income year. It still applies to an LTC that is in a joint venture or partnership with another LTC.
• Earlier losses. IR879 says any loss balance from an income year when the company wasn’t an LTC is extinguished when it becomes one. Our guide to making a company into an LTC explains what else changes.

Rental Property Losses Are Ring-Fenced

Residential rental losses follow a different rule, whatever entity holds the property. IRD’s media release on the change says that from the 2019-20 income year, landlords can’t use rental losses to offset other income, such as salary and wages. You can claim rental deductions only up to the rental income you earn. You carry forward anything over that amount and use it against rental income in future years. The release says the rules generally apply whether the property is held in a partnership, trust or a close company.*

IRD’s ring-fencing page says the rules apply to all your residential land, including overseas residential property. The media release says they don’t apply to your main home, farmland or property used mainly as business premises. Our guide to ring-fencing of property losses covers the detail.

Portfolio or Individual Property Basis

If you own more than one rental, you choose how the rules apply. IRD describes two bases:

• Portfolio basis. This is the default. IRD says the deductions for all the properties are used against all the income from them. You carry excess deductions forward unless you sell all the portfolio properties and every sale is taxable.
• Individual property basis. You can’t use one property’s deductions against another property’s income. You carry excess deductions forward unless you sell the property and the sale is taxable. If it is, you can use them against the tax on the sale.

See IRD’s pages on the portfolio basis and the individual property basis. Our guide to offsetting LTC profits and losses against other rentals shows how it works across a portfolio.

Worked Example 2: Paora and Anita’s Rental

Paora and Anita each own half of an LTC with one rental property. This year the rent totals $30,000 and the deductions total $36,000. Interest, rates, insurance and repairs add up to more than the rent. Each owner is allocated $15,000 of rent and $18,000 of deductions. That is a $3,000 loss each.

Paora earns $90,000 in wages. He can’t deduct his $3,000 from his wages, so he gets no refund. He carries the $3,000 forward.

Next year, the rent is $34,000 and the deductions are $30,000. Each owner has $17,000 of rent and $15,000 of deductions, a $2,000 profit. Paora uses $2,000 of his carried-forward $3,000. His rental profit is taxed at $0, and he carries forward the remaining $1,000.

Interest is part of why rentals show losses. IRD says the interest limitation rules have ended. Our guide to interest deductibility covers the current position.

Limited Liability Company 

Ok, this situation is totally different. If an ordinary company 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. If there is no profit, then you just keep carrying the losses forward, year to year. IRD’s company return, the IR4, has a line for “net loss to carry forward”.

It might look something like this:

Worked Example 3: Dale Holdings Limited

Dale owns all the shares in Dale Holdings Limited. In its first year, the company makes a $5,000 loss. Dale can’t use that loss on his personal return, because it stays in the company.

In year two, the company has $85,000 of taxable profit before losses. It deducts the $5,000 brought forward, so its taxable income is $80,000. IRD’s business tax rates put most companies at 28%.

• Tax without the loss: $85,000 × 28% = $23,800
• Tax with the loss: $80,000 × 28% = $22,400

The loss saves the company $1,400. The saving arrives a year later, and the company has to make a profit to get it.

The Shareholder Continuity Test

A company can’t always keep its losses. IRD’s shareholder continuity test says you may be able to carry a loss forward if at least 49% of the company’s voting shares don’t change hands. You must check this for each year you carry the loss. There is also a business continuity test, which can let a company keep its losses after a shareholder change, as interest.co.nz reported. Talk to us before you sell or issue shares in a company with losses.

Trust

If you have a trust, it’s the same as an ordinary company with respect to losses. They can’t be distributed out to the beneficiaries. IRD’s guidance on beneficiary returns says you cannot distribute losses, or parts of losses, to beneficiaries. The losses must stay with the trust.

Rather, they get carried forward until there is profit to offset them against. IRD’s page on a trust making a loss says trusts can carry losses forward from tax year to tax year until the loss is fully used or the trust is wound up.

Worked Example 4: The Whanau Trust

The Whanau Trust earns $20,000 of taxable income in year two, after making a $5,000 loss in year one. The trustees can’t pass the $5,000 loss to any beneficiary in year one. They carry it forward. In year two, they deduct it. The trust’s taxable income falls from $20,000 to $15,000.

If a trust sells or transfers a residential property within the bright-line period, IRD says any loss can only be offset against the trustees’ net income from other taxable land-sale income, including bright-line. It may be used in future years if there is no qualifying income in the current year. Keep a record of any excess deductions in case there is a taxable property sale in future. 

Partnership

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. IRD’s partnership guidance explains that partnerships don’t pay income tax. The partnership files an IR7, and each partner shows their share on their own IR3. Partners can claim partnership losses against their own personal income.

IRD says general partnerships share profits and losses equally, unless the partnership agreement states otherwise. Limited partners face loss limitation rules, and IRD offers a limited partnership loss deduction calculator for working out the deductible share.

Worked Example 5: Rewi and Soraya’s Landscaping Partnership

Rewi and Soraya run a landscaping business as a general partnership. Their agreement says nothing about how to share losses. This year the partnership makes a $10,000 loss. It shares the loss equally, so each partner has a $5,000 loss.

The partnership files an IR7 showing the loss and the split. Rewi has other income, so he claims his $5,000 against it on his IR3. Soraya does the same. If the loss had come from a residential rental, the ring-fencing rules would apply instead.

Sole Trader

A sole trader has no separate entity, so the business loss is the owner’s own. You declare your business income and expenses in your own IR3. If the business makes a loss, you can use it against your other income, such as wages, in the same return. If you have no other income, you carry it forward. Rental losses are the exception, because ring-fencing applies to you as an individual owner.

Individuals Who Own a Rental Together

If you own a rental with someone else, such as your spouse, IRD says you split the income evenly and each declare your share in your own IR3. Ring-fencing applies to each of you as an individual owner, so a rental loss can’t reduce either person’s wages.

Combos

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: the trustees can’t distribute them to beneficiaries, and carry them forward.

Note that IR879 says an ordinary company can’t hold shares in an LTC. Only a natural person, a trustee or another LTC can. That limits the combinations available.

Checklist: Before You Plan Around a Loss

• ✅ Work out which entity owns the asset or business that makes the loss
• ✅ Check whether the loss comes from residential rental property, because ring-fencing applies
• ✅ If it’s an LTC, check that the LTC election is in place and the owners’ shares are correct
• ✅ If it’s an ordinary company, track the losses carried forward and keep shareholder continuity in mind
• ✅ If it’s a trust, remember losses stay with the trust
• ✅ If it’s a partnership, check the partnership agreement for how losses are shared
• ✅ Keep a record of excess rental deductions in case of a future taxable sale
• ✅ Ask us before you restructure, sell shares or sell a property

Common Questions

Can an LTC loss reduce my salary? Yes, unless the loss comes from residential rental property. Ring-fencing stops rental losses from reducing salary.

Can my company’s loss reduce my personal tax? No. An ordinary company keeps its own loss and carries it forward against its own future profit.

Does ring-fencing apply to my family home? No. IRD’s media release says the rules don’t apply to your main home, farmland or property used mainly as business premises.

What happens to my excess rental deductions if I sell? It depends on your basis. On the portfolio basis, you carry them forward unless you sell every portfolio property and every sale is taxable. On the individual basis, you can use them against the tax on a taxable sale.

Is a loss in my financial statements the same as a tax loss? Not always. See our guide to common questions about your financial statements for why the two can differ.

Summary

The answer to “what happens if I make a loss” depends on the entity. An LTC passes its loss to its owners, who can use it against their other income. An ordinary company and a trust keep their losses and carry them forward. A partnership shares losses between its partners. Residential rental losses are ring-fenced in every case. They carry forward against future rental income and can’t reduce your salary.

Get the entity right before you plan around a loss. A refund in one structure can become a carried-forward balance in another.

Questions?

A loss can be worth real money, but only if it sits in the right entity. Don’t guess. Contact EpsomTax.com or call us on +64 9-973-0706 line 2, and we’ll tell you what your loss is worth and how to get the best result from your portfolio. 

This article is general information, not personal tax advice.

*A close company is one which is controlled by a small group of shareholders. This generally means 5 or fewer individuals or trustees must ultimately hold more than 50% of the voting interests (or the market value interests) in the company. Individuals who are associated persons can count as 1 individual.