The ‘bright-line test’ was extended to five years on 29 March 2018. While most Kiwis are debating vigorously whether the extended bright-line period has any effect on reducing speculative demand or improving housing affordability, do we all know exactly how the bright-line test works? Let’s get the basics right, unfolding the latent things to watch out for…
What is the extended bright-line test?
The bright-line property test is essentially a time-based tax rule which says that a taxpayer will pay tax on gains from the sale of a residential property within five years of purchase, unless an exception applies. The rule only applies to residential land, being land which has a dwelling on it; land for which the owner has an arrangement that relates to erecting a dwelling; or bare land that may be used for erecting a dwelling under the Auckland Unitary Plan.
When does the bright-line test apply from?
The bright-line test applies to the sale of any residential property when:
Is the ‘start date’ of the bright-line period the date when the property was bought?
‘Purchase date’ is not necessarily the ‘start date’ for the bright- line test. The ‘purchase date’ for residential property is the date when a person acquired their ‘first interest’ in the land. For standard purchases, the ‘purchase date’ would be the date a sales and purchase agreement (“SPA”) is entered into. This is typically when a binding contract to purchase the land is formed, even if a condition is still to be fulfilled.
Taxpayers need to be aware that there are a number of situations that do not follow the standard land sale process. In those situations, separate rules apply for when the bright-line period starts.
Once it is determined that a property sale falls into the bright-line test, the next step is to measure the bright-line period from the ‘start date’ to its ‘end date’.
The ‘start date’ of the bright-line period (for a standard sale) is when the land transfer is registered.
The ‘end date’ will generally be the date that you enter into an SPA for the sale of the residential property or the date the property is disposed of if there is no agreement.
Care must be taken when working out these dates as the rules require a detailed analysis to ensure they are correctly applied.
Application of the main home exception when I have more than one family home?
The main home exception means that if you buy and sell your main home, the bright-line test shouldn’t apply.
A person can only have one “main home” under this exception. If you live in more than one property, you’ll need to decide which one you have the greatest connection to. Factors to assess include where your personal property is kept; the amount of time you spend in each house; where your closest ties lie, such as family, social ties etc.
More to watch out for….
The main home exception essentially operates on an ‘all or nothing approach’. This means that this exception either applies to you or not. It does not apply on a proportional basis.
You can only use the main home exception twice over any two-year period. You would have to pay tax on any profit you make from the third sale of a ‘main home’ in two years. The main home exception won’t apply if you have a regular pattern of acquiring and disposing of residential land.
There are additional requirements as to how the main home exception applies for trust ownership, including being the main home of the ‘principal settlor’ of the trust. The ‘principal settlor’ is specifically defined under the rules. This ensures that people can’t take advantage of the main home exception for holding multiple properties through the use of trusts.
While you wrap your head around whether to buy or sell another property, or perhaps restructuring your property portfolio, there’s no better time than now to tidy up your records. Ensure you have retained relevant documentation of your property transactions. Robust evidence is necessary to keep track of how the properties have been used at least for five years (longer for trusts).
Even if the bright-line test doesn’t apply in your situation, that doesn’t necessarily mean you won’t need to pay tax on your property profits. Existing land disposal rules still apply. This includes when you buy a property with the intention to resell it, you still need to pay tax on any profit from the sale regardless of when the property was bought or sold.
The extended bright-line test will no doubt pose challenges ahead of us. Yet this is only one of the land tax changes the Government has passed and it proposes to enact more changes.
Contact your Bellingham Wallace advisor today and get yourself ready for the bright-line ‘tax’.
