Inland Revenue distinguishes between situations where the profit on the sale of the property is going to be taxed and where it is not going to be taxed. If a property is being sold and the Bright Line Test applies to make the gain taxable or the sale is taxable within the terms of part CB of the Income Tax Act 2007, ring fenced losses are set off against the resulting taxable income. Any surplus rental losses, subject to conditions stated below, can then be set off against the taxpayer’s other income.
In the vast majority of residential rental property sales, no tax is payable if the property is sold for more than it cost. The ring fenced losses are not available to set off against other income. Instead, if the taxpayer purchases another property, these can be used to offset any taxable profit made from renting the new property. Since the first property was not taxed on sale, the new property is “tainted”, which means the ring fenced losses carried forward from that property can never be released to be used to set off against other income. They can only be used against further rental profits.
The situation is simple, if a taxpayer only owns one property. However, if more than one property is owned, the taxpayer has a choice to treat their properties as a portfolio, so they can set off losses on one property against profits on another or make an election to treat particular properties as a separate tax unit. If the taxpayer makes no election, the default situation is portfolio.
If a multi property owner chooses to treat each property as a separate entity for ring fencing, then there is no loss set off between the properties.
Now here is the really nasty bit. If the properties are in a portfolio and all of them are taxed at the time of sale because of the operation of part CB of the Income Tax Act 2007 for example, carried forward rental losses cannot be set off against other income until the last property in the portfolio has been sold. It should also be noted all the properties in the portfolio must be taxable at the time of sale. If any one of them in the portfolio is not subject to tax on selling, ring fenced losses can never be set off against other income.