House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Jim Chalmers MP)

Chapter 2: Limit negative gearing for residential property to new builds

Outline of chapter

2.1 Schedule 2 to the Bill provides that expenses relating to residential dwellings used or held as residential accommodation can only be deducted against:

•

assessable income from residential dwellings used or held as residential accommodation subject to quarantining;

•

net income from such properties not subject to quarantining; or

•

revenue or capital gains on residential dwellings.

2.2 Schedule 2 to the Bill also provides that the requirement to quarantine net rental losses from residential dwellings used or held as residential accommodation does not apply to new residential dwellings, residential dwellings for an activity or purpose determined by the Minister by legislative instrument, residential dwellings for a business or enterprise of a kind determined by the Minister, or residential dwellings acquired before 7.30pm (AEST) on 12 May 2026. The requirement to quarantine amounts also does not apply to an amount incurred in providing a fringe benefit or to widely held trusts, complying superannuation entities, or an entity in a class of entities determined by the Minister by legislative instrument.

2.3 Schedule 2 to the Bill also ensures that any quarantined amount that an entity has accrued that could be carried forward is extinguished if the entity is declared bankrupt.

Context of amendments

2.4 Prior to the amendments, where deductions in respect of residential property investments (such as interest payable on a loan to purchase the property) exceeded the rental income received by the owner of the property, the net rental loss could be deducted against other assessable income, such as salary and wages and other business and investment income. This arrangement is commonly referred to as negative gearing.

2.5 Negative gearing, in combination with the 50 per cent capital gains discount, contributes to low or sometimes negative effective tax rates on property investments. These arrangements can create strong incentives for investors to take on highly leveraged housing investments, especially in established (as opposed to new) dwellings. This contributes to higher house prices – as investors bid up the price on a scarce resource.

2.6 Further, the tax benefits from negative gearing are concentrated among high income earners. Higher income individuals are more likely to invest in property, report larger rental losses, and have more negatively geared property interests.

2.7 These amendments will improve the fairness of the tax system and help address housing affordability pressures facing first homebuyers, allowing more younger Australians and future generations to own their own home. These amendments are expected to reduce investor demand for existing properties, while eligible new builds will be exempt from the changes, ensuring the benefits of negative gearing are directed to investment that support growth in Australia's housing stock.

Comparison of key features of new law and current law

Table 2.1 Comparison of new law and current law

Detailed explanation of new law

2.8 'Negative gearing' occurs when an entity's (e.g. an individual, trust, or company) deductions relating to an income-producing investment, such as residential housing, exceed the assessable income the entity earns from the investment in an income year. When this occurs, an entity's net losses can be applied against their other assessable income, such as salary and wages, business income, or other investment income. This results in a reduction in the entity's taxable income for the income year.

The general rule for loss quarantining

2.9 Schedule 2 to the Bill amends the ITAA 1997 to limit the availability of negative gearing for investments in residential dwellings used or held as residential accommodation. This is established by the general rule in Schedule 2, which sets out how to apply deductions resulting from using or holding residential dwellings as residential accommodation (i.e. residential investment properties).

2.10 First, the general rule requires that to the extent that an entity's deductions relating to quarantined residential dwellings used or held as residential accommodation in an income year exceed their assessable income from residential dwellings used or held as residential accommodation for that year, those amounts are not deductible for that income year.

2.11 To be an amount that is deductible against net assessable income from non-quarantined residential dwellings (ie residential dwellings acquired before 7.30pm (AEST) on 12 May 2026, new residential dwellings or other residential dwellings excluded by a determination made by the Minister), or revenue or capital gains from using or holding residential dwellings as residential accommodation, the amounts must relate to the use or holding of residential dwellings as residential accommodation. Relating to requires that there is some connection or association between the subject matters – i.e. the amount sought to be deducted and the residential dwellings used or held as residential accommodation. While this connection or association can be direct or indirect or substantial or real, it must be relevant. A remote or tenuous connection will not be sufficient to establish that the amounts relate to residential dwellings used or held as residential accommodation.

[Schedule 2 to the Bill, item 1, subsection 26-155(1) of the ITAA 1997]

2.12 Second, the general rule provides that those amounts that are not deductible against assessable income from using or holding residential dwellings as residential accommodation for that income year, so far as they exceed assessable income from such dwellings, can be applied as a deduction against net assessable income from non-quarantined dwellings, and revenue and capital gains on residential dwellings in accordance with the method statement in section 102-5 of the ITAA 1997. The amounts referred to are described as 'a quarantined amount'.

•

Chapter 1 of this Explanatory Memorandum explains the operation of the method statement in section 102-5 of the ITAA 1997.

[Schedule 2 to the Bill, item 1, paragraph 26-155(1)(b) of the ITAA 1997]

2.13 The cost base and reduced cost base of a CGT asset, including a residential dwelling, is used in calculating the amount of a capital gain or loss from a CGT event that happens to that CGT asset. Expenditure that can be deducted is usually excluded from the CGT asset's cost base and reduced cost base. Consistent with this principle, amounts that are quarantined, including amounts applied to reduce residential capital gains, are not included in a residential dwelling's cost base or reduced cost base. This ensures that the amounts are not recognised twice.

[Schedule 2 to the Bill, items 2 and 3, subsections 110-38(8A) and 110-55(9JA) of the ITAA 1997]

2.14 Third, the general rule provides that to the extent any part of a quarantined amount remains after applying it in accordance with the method statement in section 102-5 of the ITAA 1997, that remaining amount can be carried forward and applied as a deduction against assessable income from using or holding residential dwellings as residential accommodation in the next income year or taken into consideration in determining any capital gain or loss from a CGT event happening to residential dwellings in a future income year.

2.15 How quarantined amounts are carried forward is discussed at paragraphs 2.67 to 2.77 below.

[Schedule 2 to the Bill, item 1, paragraph 26-155(1)(c) of the ITAA 1997]

2.16 The general rule for loss quarantining does not apply to other types of investments – for example, shares or commercial property, as it is only intended to apply to established residential dwellings. An entity can continue to deduct all losses and outgoings from owning other types of investments in an income year against assessable income from other sources in that income year – for example, against their salary and wages. If their deductions from holding non-residential investments exceed all other assessable income and net exempt income, then they can carry forward any losses not applied in that income year under the existing income tax loss rules to apply against any assessable income in subsequent income years.

Meaning of residential dwelling

2.17 For the general rule for loss quarantining to apply, the entity's investment must be in a residential dwelling used or held as residential accommodation.

[Schedule 2 to the Bill, item 1, subsection 26-155(1) of the ITAA 1997]

2.18 A 'residential dwelling' is a dwelling, within the meaning of section 118-115 of the ITAA 1997, other than any of the following:

•

a caravan, mobile tiny home, or other mobile home;

•

a hotel, motel, inn, hostel, or boarding house;

•

dwellings providing accommodation to students in connection with a *school or an *education institution that is not a school;

•

a boat or other marine vessel; or

•

a dwelling in a class of dwellings determined by the Minister by legislative instrument.

[Schedule 2 to the Bill, items 1 and 4, subsections 26-160(1) and 995-1(1) definition of residential dwelling of the ITAA 1997]

2.19 Further, the meaning of residential dwelling includes any adjacent land to the dwelling or structures, such as a garage, storeroom or other structure associated with the dwelling, for use by the occupant of the residential dwelling. This extension of the meaning of residential dwelling is intended to ensure that all of the land and structures that are on an entity's property are included by the term residential dwelling.

[Schedule 2 to the Bill, item 1, subsection 26-160(2) of the ITAA 1997]

2.20 This means that a residential dwelling is a unit of accommodation that is a building or is contained in a building; and consists wholly or mainly of residential accommodation; and any land immediately under the unit of accommodation, as well as any adjacent land and structures to the extent the land was used primarily in association with the dwelling as residential accommodation. A residential dwelling includes detached and semi-detached houses, units, apartments and townhouses.

2.21 The requirement that a residential dwelling is a dwelling limits the general rule to the types of buildings that are able to be occupied as residential accommodation. However, there is no restriction based on the length of time the residential dwelling is able to be continuously occupied for. For example some dwellings such as apartments may be rented by their owner for short stay accommodation, despite being suitable for long term rental. However, the term residential dwelling specifically excludes certain types of short-term accommodation from being able to be a residential dwelling – such as a hotel, motel, inn, hostel or boarding house.

2.22 An entity can use or hold a residential dwelling as their main residence at the same time as using or holding the residential dwelling as residential accommodation to gain rental income. In this situation, it is not possible for an entity to claim deductions in relation to the portion of the residential dwelling used as their main residence. The entity must therefore apportion their deductions so they are limited to the part of the dwelling that is used or held as residential accommodation (i.e. the portion that is rented out and generating income).

Example 2.1 Quarantining of rental losses from a residential dwelling

Nikolai purchases a split-level house with dual street frontage on 1 August 2027 with a $700,000 mortgage. The house is his main residence. However, after he moves in, he decides to rent out the downstairs rooms and backyard, including a gardening shed, to a tenant to help cover his mortgage repayments.

Nikolai cannot claim a deduction for expenditure to the extent that it relates to that part of the house used as his main residence (i.e. the upstairs rooms and front yard) as it does not relate to gaining or producing his assessable income. Expenditures related to income earned from the part of the house he rents out (i.e. downstairs rooms, backyard and shed) to his tenant are subject to loss quarantining, if they exceed Nikolai's income from this source. If Nikolai has a net loss from renting this portion of his house, the remaining losses can be carried forward to later income years and deducted against any assessable income from residential dwellings used or held as residential accommodation and any revenue or capital gains arising from disposals of residential dwellings.

Dwellings that are not residential dwellings

2.23 In addition to the dwellings identified in subsection 26-160(1) of the Bill that are excluded from the definition of residential dwellings, the instrument-making power enables the Minister to determine that a dwelling in a class of dwellings is also not a residential dwelling. This power enables the exclusion of further types of dwellings that are identified as not intended to be included in the residential dwelling definition and therefore not subject to loss quarantining. This is necessary to ensure that the intent of these amendments, which is to limit negative gearing to new residential dwellings, certain prescribed dwellings, certain prescribed entities, and residential dwellings last acquired before 7.30pm (AEST) on 12 May 2026, does not result in unintended outcomes.

[Schedule 2 to the Bill, item 1, paragraph 26-160(1)(e) of the ITAA 1997]

2.24 Further, section 12 of the Legislation Act 2003, which requires that legislative instruments can only apply prospectively from the date of registration of the instrument, ensures that determinations made by the Minister cannot disadvantage entities through retrospective application.

2.25 Finally, the legislative instrument is disallowable and subject to sunsetting, therefore enabling any determinations made by the Minister to be subject to Parliamentary scrutiny.

2.26 It is also possible for a dwelling that was a residential dwelling to cease being a residential dwelling. This would arise where the nature of the use of the residential dwelling changes.

Example 2.2 Residential dwelling ceases being subject to the general rule requiring loss quarantining

Olivia acquires a large multi-bedroom house on 1 August 2027. She does not hold any other residential dwellings used or held as residential accommodation. Olivia immediately advertises the property for rent. On 1 September 2027, she enters into a 12-month lease agreement with Harriet, Tristan and Ada to rent the property. For the 2027-28 income year, the interest deductions on the mortgage, as well as other property expenses, are available only to deduct against her rental income.

In January 2028, Olivia applies for planning permission to re-zone her property so that it can be used as a boarding house. On 1 October 2028, approval for the re-zoning is granted and Olivia enters into boarding agreements with a number of boarders. This means Olivia's house was only a residential dwelling for three months of the 2028-29 income year, despite her earning income for the whole of that income year.

Olivia must now apportion her income from the property into rental income and boarding income and the related deductions into two categories. The property's losses and outgoings during the first three months of that income year can only be deducted against Olivia's rental income from the first three months of the year (i.e. they are quarantined). Olivia's losses and outgoings for the rest of the income year (i.e. after the property is rezoned as a boarding house) can be deducted against all of her assessable income as loss quarantining does not apply to losses or outgoings incurred in deriving income from a boarding house.

Exceptions to the general rule for loss quarantining

2.27 The general rule requiring an entity to quarantine amounts from residential dwellings used or held as residential accommodation does not apply in relation to amounts from a residential dwelling:

•

in which the entity's ownership interest in a residential dwelling was last acquired before 7.30pm (AEST) on 12 May 2026; or

•

that is a new residential dwelling in which the entity has an ownership interest; or

•

that is a residential dwelling used for an activity or purpose determined by the Minister by legislative instrument; or

•

that is a residential dwelling for a business or enterprise of a kind determined by the Minister by legislative instrument.

[Schedule 2 to the Bill, item 1, subsection 26-155(2) of the ITAA 1997]

Ownership interest in a residential dwelling acquired prior to 7.30pm (AEST) on 12 May 2026

2.28 The general rule for loss quarantining does not apply to an ownership interest in a residential dwelling an entity last acquired before 7.30pm (AEST) on 12 May 2026. Accordingly, an entity can apply any excess deductions incurred in generating income from such a dwelling against other types of assessable income the entity has derived in an income year, such as salary and wages, business, or other investment income.

[Schedule 2 to the Bill, item 1, paragraph 26-155(2)(a) of the ITAA 1997]

2.29 The concept of 'ownership interest', as provided for in section 118-130 of the ITAA 1997, determines when an entity becomes the owner of land or a dwelling or gains a right or licence to occupy the land. Schedule 2 to the Bill modifies when an entity acquires an ownership interest in a residential dwelling last acquired prior to 7.30pm (AEST) on 12 May 2026 under a contract. Accordingly, when an entity has an ownership interest in such a dwelling, it will be based on the time when the entity enters into the contract to purchase the dwelling.

[Schedule 2 to the Bill, item 1, subsection 26-155(3) of the ITAA 1997]

2.30 This expands the concept of when an ownership interest is acquired under section 118-130 of the ITAA 1997. This modification is necessary to support the exemption from loss quarantining applying to a residential dwelling used or held as residential accommodation last acquired before 7.30pm (AEST) on 12 May 2026.

2.31 When an asset is 'acquired' is set out in sections 109-5 and 109-10 of the ITAA 1997. Generally, a CGT asset, which includes a residential dwelling, is acquired by an entity when an entity becomes the asset's owner.

2.32 Sections 109-5 and 109-10 of the ITAA 1997 set out a number of specific rules for particular situations. These situations include where an entity voluntarily disposes of a CGT asset to another entity, in which case, the entity acquires the asset either when the disposal contract is entered into, or, if there is no contract, when the other entity ceases to be the owner of the asset (item 1 of the table in section 109-5 of the ITAA 1997).

2.33 Generally, most residential dwellings will have been acquired by an entity at the time when the entity entered into the binding contract to purchase the residential dwelling, or when the entity entered into a contract to purchase the vacant land upon which the residential dwelling was later constructed.

2.34 The ownership interest that an entity acquires in the residential dwelling does not need to be the whole freehold or leasehold interest in the property. In some cases, an entity may only be entitled to a share in the property or may have more limited rights in respect of the dwelling. This does not prevent the measure applying to the entity's income and losses resulting from the residential dwelling used or held as residential accommodation.

2.35 For the purposes of CGT, a joint tenancy arrangement is treated as a tenants-in-common arrangement. This means that where the nature of the joint tenancy arrangement changes on or after 7.30pm, (AEST) on 12 May 2026 so that, for example, where one of the two joint tenants owners of a property held as a joint tenancy interest ceases to have an interest in the property, the remaining owner is treated as having acquired a new ownership interest from the departing joint tenant in a residential dwelling. This new interest (but not the original interest) is subject to the requirement to quarantine losses similar to where a tenants-in-common interest was held.

Interests in real property acquired before 7.30pm (AEST) on 12 May 2026 that are exempt from the general rule

2.36 The general rule that net rental losses from a residential dwelling used or held as residential accommodation are quarantined does not apply to the following interests in real property:

•

real property interest in land with a residential dwelling on it at 7.30pm (AEST) on 12 May 2026;

•

real property interest in vacant residential land on which a residential dwelling is built on the land after 7.30pm (AEST) on 12 May 2026; or

•

real property interest in land where a residential dwelling is being built or is contracted to be built and the completion of construction occurs after 7.30pm (AEST) on 12 May 2026.

2.37 Accordingly – for real property interests in vacant land; land on which construction has commenced, where a dwelling is being demolished or is in any other state as at Budget night on 12 May 2026 – the restrictions under the amendments in this Schedule will not apply to building or rebuilding on that real property interest. However, other provisions in the tax law may limit deductibility of amounts, such as the existing limitation on deducting amounts related to holding vacant land.

Example 2.3 Ownership interest in vacant land pre-12 May 2026

David acquired an ownership interest in vacant land prior to 7.30pm (AEST) on 12 May 2026 and therefore it is not subject to the loss quarantining rules. He took out a loan to acquire the vacant land and is incurring interest charges. While the land is vacant, section 26-102 of the ITAA 1997 prevents David from deducting the interest charges (and any other losses or outgoings) in relation to this ownership.

In July 2027, David engages builders to commence construction of a residential dwelling on his vacant land.

On 1 July 2028, construction is completed, and an occupancy certificate is issued for the residential dwelling and David enters into a lease agreement with Kathy to rent the residential dwelling.

For the 2028-29 and later income years David rents the property and his rental deductions continue to exceed his rental income. David is able to claim rental deductions, such as the interest paid on the loan for the land, as they are incurred in gaining or producing his rental income. The effect of this is that the total of David's assessable income, which includes salary and wages is reduced as his rental deductions exceed his rental income.

Example 2.4 Ownership interest in an established dwelling pre-12 May 2026

Maya acquired an ownership interest in a residential dwelling prior to 7.30pm (AEST) on 12 May 2026 (Dwelling A). This dwelling is her main residence and is subject to a home loan for which she pays interest and makes principal repayments.

On 25 August 2029, Maya moves to another city and seeks to rent the apartment. On 1 September 2029, Maya advertises Dwelling A for rent and rents Dwelling A to a tenant.

For the 2029-30 income year, Maya is able to claim deductions, such as interest paid on the loan for Dwelling A, against her assessable income, including her salary and wages, for the period 1 September 2029 to 30 June 2030.

A new residential dwelling in relation to an entity

2.38 The general rule for loss quarantining does not apply to a residential dwelling used or held as residential accommodation that is a new residential dwelling in relation to the entity. This means that these deductions can be applied against other types of assessable income an entity has derived in an income year, such as salary and wages and business and other investment income.

[Schedule 2 to the Bill, item 1, paragraph 26-155(2)(b) of the ITAA 1997]

2.39 A residential dwelling is a 'new residential dwelling' in relation to the entity if the requirements determined by the Minister by legislative instrument are met.

[Schedule 2 to the Bill, items 1 and 4, subsections 26-160(3) and (4) and subsection 995-1(1) definition of new residential dwelling of the ITAA 1997]

2.40 New residential dwellings are a sub-set of residential dwellings which, in-turn, apply the meaning of 'dwelling' in section 118-115 of the ITAA 1997. Thus, the types of dwellings that are excluded from being residential dwellings cannot be a new residential dwelling.

2.41 The Minister must determine the requirements for a new residential dwelling by legislative instrument. The requirements that the Minister must determine may include one or more of the following:

•

the kind of residential dwelling; or

•

the kind of interest the entity holds in the residential dwelling and the circumstances in which the entity acquired the interest (such as whether the entity was the builder/developer or a subsequent purchaser of the residential dwelling); or

•

circumstances relating to the creation of the residential dwelling (such as whether the residential dwelling was built on vacant land, was created through substantial renovations of an existing building, or was built to replace a demolished residential dwelling); or

•

whether the residential dwelling has a separate legal title or equitable interests or similar that can be acquired by an entity; or

•

whether the residential dwelling genuinely adds to the supply of residential dwellings in Australia.

[Schedule 2 to the Bill, item 1, subsection 26-160(4) of the ITAA 1997]

2.42 Further, as part of determining the requirements for a new residential dwelling, the amendments enable the Minister to determine requirements relating to matters or circumstances existing before the commencement of the requirement to quarantine amounts for residential dwellings used or held as residential accommodation. This ensures that any determination can deal with pre-commencement circumstances as necessary to achieve the required policy intent.

[Schedule 2 to the Bill, item 1, subsection 26-160(5) of the ITAA 1997]

2.43 Without limiting the scope of the requirements for new residential dwellings, examples include where:

•

The residential dwelling has been constructed and not previously been sold. This would include residential dwellings constructed as part of greenfield developments.

•

The residential dwelling constructed must genuinely add to housing supply in Australia. This would include where a single residential dwelling is demolished, and two separately titled duplexes are constructed. Both duplex dwellings would be considered to be new residential dwellings. Where an existing dwelling is demolished and replaced with a single dwelling this would not satisfy the requirement of adding to housing supply.

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A requirement for a new residential dwelling to genuinely add to supply in Australia would ensure that properties located outside Australia cannot be new residential dwellings and therefore access negative gearing.

•

The residential dwelling is a unit in an apartment block that has been constructed. The unit is leased by the developer but then sold within 12 months of the completion of construction. In this case the unit is still considered 'new' and can be negatively geared.

2.44 The delegation of legislative power is appropriate as the settings for the types of investment to be excluded from these new negative gearing settings may need to be fine-tuned from time-to-time to respond to changing circumstances. Property and housing construction is a complex environment. There is a broad spectrum of property types, with emerging models of property development. It is appropriate for the legislative power to be delegated as the range and complexity of different kinds of developments may require detailed specifications about what will be considered a new residential dwelling in particular contexts, involving a level of detail that is better suited to delegated legislation.

2.45 Further, the Bill constrains the ability of the Minister to define what is a new residential dwelling by requiring that a new residential dwelling must satisfy the definition of a residential dwelling. This restriction in the Bill ensures that Parliament retains a level of oversight over the definition of new residential dwelling made by the Minister.

2.46 The Minister's ability to define what is a new residential dwelling is also restricted to ensure a person is not disadvantaged by any retrospective application. Section 12 of the Legislation Act 2003 provides that a legislative instrument does not apply retrospectively if it results in a person's rights as at the time the instrument is registered being affected so as to disadvantage the person. This ensures requirements made by the Minister only apply prospectively, or retrospectively only to the extent that they benefit a person. While subsection 12(4) of the Legislation Act 2003 allows an Act to override this, subsection 26-160(5) of the Bill does not do this.

2.47 Accordingly, any changes to the definition of a new residential dwelling that could disadvantage entities can only apply for periods after registration of the Ministerial determination. This protects affected entities and provides assurance that the determination making power cannot result in an entity's past tax assessments being adversely affected. The rule-making power will benefit affected entities as it allows scope for additional classes of dwellings to be excluded from the operation of the quarantining provisions – and therefore able to access negative gearing.

2.48 Finally, the legislative instrument would be subject to disallowance and would sunset after ten years and will therefore be subject to appropriate parliamentary oversight and scrutiny. The government intends to release the details of this legislative instrument publicly as soon as possible after introduction of the Bill to Parliament.

Residential dwellings determined by the Minister

2.49 Using or holding a residential dwelling for an activity or purpose determined by the Minister by legislative instrument is not subject to the general rule requiring that net rental losses from a residential dwelling used or held as residential accommodation are quarantined.

[Schedule 2 to the Bill, item 1, paragraph 26-155(2)(c) of the ITAA 1997]

2.50 Additionally, using or holding a residential dwelling for a business or enterprise of a kind determined by the Minister by legislative instrument is also not subject to the general rule requiring that net rental losses from a residential dwelling used or held as residential accommodation are quarantined.

[Schedule 2 to the Bill, item 1, paragraph 26-155(2)(d) of the ITAA 1997]

2.51 Without limiting the residential dwellings that could be determined by the Minister in relation to a business or enterprise under these instrument-making powers, an example of residential dwellings that could be determined in relation to a business or enterprise include, using or holding residential dwellings as rental properties to provide social or affordable housing.

2.52 This delegation of legislative power is appropriate as there are many different types of residential housing in existence now that provide concessionally priced rental accommodation to persons with particular needs. There are likely to be new types emerging in the future and changes to existing concessional rental accommodation types, and it would be impractical for the primary law to identify all these types of housing. Accordingly, it is appropriate to allow the Minister to use subordinate legislation to exclude certain types of housing from the requirement to quarantine losses given these factors. Additionally, the power is constrained as the Minister can only prescribe types of housing that are residential dwellings, which is a term defined in the primary law.

2.53 The legislative instrument would be subject to disallowance and would sunset after ten years and will therefore be subject to appropriate parliamentary oversight and scrutiny.

Further exceptions to the general rule for loss quarantining

Exception for certain kinds of entities

2.54 The general rule requiring that net rental losses from a residential dwelling used or held as residential accommodation be quarantined does not apply to the following entities:

•

widely held trusts (for example, most managed investment trusts).

•

complying superannuation entities (i.e. complying superannuation funds including self-managed superannuation funds, complying approved deposit funds and pooled superannuation trusts).

[Schedule 2 to the Bill, item 1, subsection 26-155(4) of the ITAA 1997]

2.55 Additionally, the restrictions on negative gearing introduced by this Schedule do not apply to an entity in a class of entities determined by the Minister by legislative instrument.

[Schedule 2 to the Bill, item 1, paragraph 26-155(4)(c) of the ITAA 1997]

2.56 Providing the Minister with this power is intended to allow additional types of entities to be prescribed for the purpose of excluding them from the requirement to quarantine amounts. This ensures that the new quarantining arrangements can be limited should their application to particular types of entities cease to be consistent with overall housing and tax policy considerations in light of changing circumstances.

2.57 The legislative instrument would be subject to disallowance and sunset after ten years and will therefore be subject to appropriate parliamentary oversight and scrutiny.

Exception for fringe benefits

2.58 An exception to the rules quarantining losses on residential dwellings used or held as residential accommodation applies to expenditure an employer incurs in providing a fringe benefit. This ensures that the changes do not affect businesses that directly provide housing to their employees.

[Schedule 2 to the Bill, item 1, subsection 26-155(5) of the ITAA 1997]

2.59 The effect is that expenditure incurred in providing a fringe benefit (for example, in providing a residential dwelling as a housing fringe benefit) is not subject to quarantining. This is consistent with the general treatment under the income tax law of expenses in providing fringe benefits and other loss quarantining provisions like section 26-47 of the ITAA 1997 concerning non-business boating activities.

Modifications to the general rule for loss quarantining

2.60 The requirement to quarantine amounts from a residential dwelling used or held as residential accommodation (other than where there is an exception) applies to net losses incurred in income years starting on 1 July 2027 in relation to a residential dwelling that is acquired on or after 7.30pm (AEST) on 12 May 2026.

[Schedule 2 to the Bill, item 5]

Modification in relation to certain gains

2.61 The general rule that requires loss quarantining for residential dwellings used or held as residential accommodation is modified where in an income year an entity has:

•

assessable income from non-quarantined residential dwellings that exceeds the entity's deductions relating to those non-quarantined residential dwellings; or

•

gains from the realisation of a residential dwelling that is a revenue asset.

2.62 In these cases, the amount of net losses from the using or holding of residential dwellings as residential accommodation is reduced by the amount of assessable income that exceeds the deductions from non-quarantined residential dwellings or gains from the realisation of a residential dwelling that is a revenue asset.

2.63 The reduced amount of net rental losses from using or holding residential dwellings as residential accommodation is then applied to capital gains in accordance with section 102-5 of the ITAA 1997 and any amount remaining after being applied is carried forward to the next income year.

[Schedule 2 to the Bill, item 1, subsection 26-155(6) of the ITAA 1997]

Modification in relation to beneficiaries of trusts

2.64 The general rule is modified in relation to beneficiaries of trusts. This modification ensures that the character of trust income flows through to beneficiaries of trusts to enable beneficiaries to apply trust income to the extent that it has the character of income from residential premises used as residential accommodation against any losses they may have from quarantined residential properties. This ensures that such beneficiaries are not adversely impacted where a trust distributes net income to them from such a source. The modification rules also allow the look through test to apply through interposed partnerships and trust estates also.

2.65 Similarly, the modification ensures that where an entity takes out a loan to acquire an interest in a unit trust, the interest costs for the loan will be subject to the operation of the general rules for loss quarantining for a property acquired by the unit trust that distributes net income to the entity.

[Schedule 2 to the Bill, item 1, subsection 26-155(7) of the ITAA 1997]

Modification where an entity becomes bankrupt

2.66 The general rule for loss quarantining is modified where an entity is declared bankrupt, is released from a debt under bankruptcy law or in certain cases where an existing bankruptcy is annulled under a composition or scheme of arrangement. In these cases, a quarantined amount that arises before bankruptcy cannot be deducted against assessable income from using or holding residential dwellings or applied to reduce capital gains arising from residential dwellings and new residential dwellings after a taxpayer is declared bankrupt. This includes any quarantined amounts generated in the year that the taxpayer is declared bankrupt. This exception follows the model in section 26-47 (about quarantining losses for non-business boating activities), Divisions 35 (about deferral of losses from non-commercial business activities) and Division 36 (about deducting losses generally under the tax law) of the ITAA 1997.

[Schedule 2 to the Bill, item 1, subsections 26-155(8) and (9) of the ITAA 1997]

Following the general rule and determining if there is a carry-forward loss

2.67 The following steps outline the process for complying with the general rule for quarantining losses and determining if you have a quarantined amount to be carried forward and applied in the next income year.

Step 1 – Determine whether the quarantining provisions apply - entities

2.68 You are not required to complete any of the following steps if you are an excluded entity. These are a widely held trust, complying superannuation entity or an entity determined by the Minister (see paragraphs 2.54 to 2.57) above.

Step 2 – Determine any net income amount, disregarding exceptions from the general rule

2.69 Consider amounts that you can deduct (including quarantined amounts from the previous income year) and amounts of assessable income that relate to the using or holding of residential dwellings as residential accommodation. This includes amounts you receive as a beneficiary of a trust estate (see paragraphs 2.64 and 2.65 above).

2.70 You should then disregard any amounts that you can deduct and any amounts of assessable income that are covered by the exceptions. This includes amounts in relation to the using or holding of the following:

•

an ownership interest in a residential dwelling you last acquired before 7.30 pm, (AEST) on 12 May 2026 (see paragraphs 2.28 to 2.35);

•

a residential dwelling that is a new residential dwelling in relation to you (see paragraphs 2.38 to 2.48);

•

a residential dwelling used or held for an activity, purpose, business or enterprise of a kind determined by the Minister by legislative instrument (see paragraphs 2.49 to 2.53);

•

an amount relating to providing a fringe benefit (see paragraphs 2.58 to 2.59).

2.71 If, after excluding amounts covered by the exceptions, the amount you can deduct exceeds the amounts of assessable income, you have an excess amount that may be reduced in subsequent steps.

Step 3 – Determine whether the net income amount can be reduced

2.72 Consider amounts that you can deduct and amounts of assessable income that relate to the using or holding of residential dwellings as residential accommodation, that are covered by subsection 26-155(2) of Schedule 2.

2.73 If the amounts you can deduct exceed the amounts of assessable income, the excess amount is disregarded for the purposes of quarantining and you can deduct this excess amount against your other assessable income, consistent with current settings.

2.74 If the amounts of assessable income exceed the amounts that you can deduct, you then add this excess to any gains realised for income tax purposes for the income year from a realisation event occurring in relation to a residential dwelling that is a revenue asset. You can then use the sum of these two amounts to reduce the excess from step 2. If any excess from step 2 remains after applying this reduction, this remaining excess is not deductible for the income year and is considered a quarantined amount.

Step 4 – Apply your quarantined amount against any capital gains from residential dwellings

2.75 You then apply any quarantined amounts you have in an income year against any capital gains relating to residential dwellings in accordance with the method statement in section 102-5 of the ITAA 1997 (about working out your net capital gain). The method statement sets out the rules for offsetting quarantined amounts.

Step 5 – Carry forward any remaining quarantined amount to the next income year

2.76 To the extent you have any remaining quarantined loss after following the above steps, it is treated as an amount relating to using or holding residential dwellings as residential accommodation that you can deduct in the next income year. Also consider if the special rules concerning gains on revenue account, bankruptcy and fringe benefits apply.

2.77 This allows you to carry forward any unused net rental losses to be used in future income years. In each income year you then follow the above steps, to determine if you have a remaining quarantined loss to be applied to the next income year.

Example 2.5 Applying the general rule and carrying forward quarantined losses

Tyson owns four residential dwellings which he rents out to derive rental income. Residential Dwellings A and B were acquired in 2025 and are not subject to the quarantining rules. Residential Dwellings C and D were acquired after 7.30 pm AEST on 12 May 2026 and are subject to the quarantining rules.

In all income years, Tyson meets Step 1 (exclusion of exempt entities), given he is not an exempt entity.

Treatment in 2027-28 income year

The net income from Tyson's residential dwellings for the 2027-28 income year are as follows:

Property	Net rental income/loss in 2027-28 ($) after offsetting deduction
Residential Dwelling A (negative gearing applies)	3,000
Residential Dwelling B (negative gearing applies)	2,000
Residential Dwelling C (quarantined)	5,000
Residential Dwelling D (quarantined)	-15,000

Step 2: Determine any net income amount, disregarding exceptions from the general rule

Tyson considers the amounts he can deduct, and the amounts of assessable income that relate to the using and holding of residential dwellings for residential accommodation. In doing so, he disregards these amounts from Dwellings A and B given they relate to using or holding residential dwellings covered by the relevant exceptions. This means Tyson considers Dwellings C and D, and whether there is an excess amount.

For the 2027-28 income year, there is an initial excess amount of $10,000 for Dwellings C and D.

Step 3: Determine whether the net income amount can be reduced

Next Tyson considers amounts that he can deduct and amounts of assessable income that relate to the using or holding of residential dwellings as residential accommodation, that are covered by subsection 26-155(2) of Schedule 2. In this case, this is Dwellings A and B, for which he has net income of $5,000 for the 2027-28 income year.

He then reduces the initial excess amount of $10,000 by this amount of $5,000, leaving a quarantined amount of $5,000 for the 2027-28 income year. This quarantined amount is not deductible for the 2027-28 income year.

Step 4: Apply your quarantined amount against any capital gains from residential dwellings

Tyson then considers if he has any capital gains relating to residential dwellings in the 2027-28 income year that he can apply the quarantined losses against, in accordance with the method statement in section 102-5 (about working out your net capital gain). For this income year he has none.

Step 5: Carry forward any remaining quarantined amount to the next income year

Tyson would then treat the remaining quarantined loss of $5,000 as an amount relating to using or holding residential dwellings as residential accommodation that he can deduct in the next income year (2028-29). This allows Tyson to carry forward the unused quarantined amount.

Example 2.6 Applying carried forward quarantined losses against net rental income and capital gains

Treatment in 2028-29 income year

Assume the same facts as Example 2.5. Tyson has a $5,000 carry forward loss from the 2027-28 income year, which is taken to be an amount relating to the using or holding of residential accommodation in the 2028-29 income year. Tyson disposes of Dwelling B in the year for a capital gain of $20,000.

The net income and capital gains from each residential dwelling is as follows:

Property	Net rental income in 2028-29 ($)	Capital gain in 2028-29 ($)
Residential Dwelling A (negative gearing applies)	5,000
Residential Dwelling B (negative gearing applies)	-1,000	20,000
Residential Dwelling C (quarantined)	8,000
Residential Dwelling D (quarantined)	-10,000
Quarantined loss carried forward from previous income year	-5,000

Step 2: Determine any net income amount, disregarding exceptions from the general rule

Tyson considers the amounts he can deduct, and the amounts of assessable income that relate to the using and holding of residential dwellings for residential accommodation. In doing so, he disregards these amounts from Dwellings A and B given they relate to using or holding residential dwellings covered by the relevant exceptions. This means Tyson considers Dwellings C and D as well as his carried forward loss from the 2027-28 income year, to determine if there is an excess amount.

For the 2028-29 income year, there is an initial excess amount of $7,000.

Step 3: Determine whether the net income amount can be reduced

Next Tyson considers amounts that he can deduct and amounts of assessable income that relate to the using or holding of residential dwellings as residential accommodation, that are covered by subsection 26-155(2) of Schedule 2. In this case, despite Dwelling B having a rental loss of $1,000, the total amount from Dwellings A and B, is net income of $4,000 for the 2028-29 in the income year.

He then reduces the initial excess amount of $7,000 by this amount of $4,000, leaving a quarantined amount of $3,000 for the 2028-29 income year. This quarantined amount is not deductible for the 2028-29 income year.

Step 4: Apply your quarantined amount against any capital gains from residential dwellings

Tyson then considers if he has any capital gains relating to residential dwellings in the 2028-29 income year that he can apply the quarantined losses against, in accordance with the method statement in section 102-5 (about working out your net capital gain). For the 2028-29 income year, he has $20,000 of capital gains relating to residential dwellings. Consistent with the method statement, Tyson applies the $3,000 quarantined amount against his capital gain of $20,000. This reduces the capital gain to $17,000 for the 2028-29 income year.

Step 5: Carry forward any remaining quarantined amount to the next income year

After following all the preceding steps, Tyson does not have a quarantined amount to be carried forward to the next income year.

Commencement, application, and transitional provisions

2.78 Schedule 2 to the Bill commences on the day after the Bill receives Royal Assent.

[item 5 of the commencement table in clause 2 of the Bill]

2.79 The amendments in Schedule 2 to the Bill apply to net rental losses incurred in the 2027-28 income year and later income years in relation to interests in residential dwellings acquired on or after 7.30pm (AEST) on 12 May 2026, unless otherwise excluded. The effect of this application provision is that owners of all residential dwellings acquired under binding contacts entered into, from the time of the Budget announcement until 30 June 2027 can fully deduct losses for the income year ending on 30 June 2027 only. However, such net losses must be quarantined from 1 July 2027.

[Schedule 2 to the Bill, item 1, paragraph 26-155(2)(a) of the ITAA 1997; item 5]