Losses on rental property disallowed for Japanese taxes

On 12 December 2019, the Japanese government announced tax changes for 2020 including provisions that will affect internationally mobile employees who have rental properties outside Japan. The changes limit the ability of taxpayers to offset losses from buildings that are not newly built.

Under Japanese depreciation rules, the ‘useful life’ of a building may have already lapsed if it was built a number of years ago. For example, the useful life of a residential apartment with steel and concrete construction is 47 years under existing Japanese tax regulations. For example, if the building was built in 1950, its useful life lapsed in 1997.

A taxpayer purchasing this apartment (treated as 'second-hand real estate' for Japanese tax purposes) in 2020 would still be able to depreciate this apartment over nine years. Where property is rented to generate income, this often results in a net loss due to the large amount of depreciation expense taxpayers can deduct. For many years, this has been used as a tax saving mechanism as the net loss generating from real estate rental income can be offset against income from other sources including employment income.

Key changes

Effective 1 January 2021, taxpayers in Japan will not be allowed to offset losses generating from the rental of overseas 'second-hand' real estate against other income.

If an individual has a loss from the rental of second-hand overseas real estate using method one, two or three below to calculate depreciation expense, the portion of the loss corresponding to the depreciation expense will be disallowed and cannot be offset against income from other sources.

This change will effectively close the tax saving opportunity that remained available to international assignees and foreign nationals in Japan leasing their apartment or house in their home country or other countries during assignment or residency in Japan.

1. For assets that have lapsed all of their statutory useful lives, a method in which the useful life is equal to 20% of their statutory useful lives
2. For assets that have lapsed a portion of their statutory useful lives, a method in which the useful life is calculated as a sum of (i) the statutory useful life of the asset less elapsed years and (ii) 20% of the elapsed years
3. A method in which years of useful period after the property has been placed in service is used as the useful life. An exception is allowed for method 3.
   
   Under method 3, if the taxpayer attaches documents to evidence that the useful life of the overseas second-hand real property in accordance with laws and regulations of the jurisdiction where the overseas second-hand real property is located is used or otherwise evidences that the years of useful period is appropriate, depreciation expense will be allowed.

If a taxpayer subject to the limitation of depreciation expense on overseas second-hand real property later sells that real property, the limited depreciation expense shall not be deducted in calculating the cost basis of that real property for purposes of calculating capital gain. It will generally result in reducing the capital gain.

Please note that detailed application may change depending on further legislations.

Get in touch

If you would like to discuss the full implications of these changes, please contact Tosh Kamii, Grant Thornton Japan or your local Grant Thornton office.

Read more insights on tax changes affecting internationally mobile employees.