In the age of data, Inland Revenue has access to more information than ever before. That means they are watching property sales closely to ensure that tax payers include any property sales caught by the bright-line test in their tax returns.
We have recently been notified by the Inland Revenue that they believe several of our clients property sales meet the bright-line rules. And so with this in mind, we thought it timely to review the bright-line rules.
Bright-line test and residential land
Tax rules apply to residential property sales made from 1 October 2015.
The ‘bright-line test’ applies where a person who has purchased a residential property on or after 1 October 2015 then sells it within two years, or on or after 29 March 2018 and sells it within five years.
The sale will be taxed unless the property is the seller’s main home, inherited from a deceased estate or sold as part of a relationship property settlement. The bright-line test does not apply to business premises or farmland.
How the start and end date of the bright-line test is counted varies with the type of sale and purchase it is. For instance, where it’s a standard purchase, the start date will be the date a person obtains registered title for the property and the end date will be the date of entry into agreement for sale. However, start and end dates will be calculated differently where the registration date may not take place immediately or be the definitive point of transfer - sales off the plan, sales of subdivided land, mortgagee sales or where property is gifted to a trust.
Selling the main home
The seller’s main home is exempt from the bright-line test. Where the seller has more than one home, their ‘main home’ is the property with which they have the greatest connection. Just to prove that the tax system has a sense of humour, a person will not be able to use the main home exception if they have already used it twice in the previous two years.
It may get tricky for family trusts where family assets are distributed between individual owners and the trust. If a trust owns the property being sold, the main home exception will apply when it’s the main home of a beneficiary of the trust. However, if the principal settlor of the trust has a main home that the trust doesn’t own, the main home exception cannot apply to any property owned by the trust.
Claiming tax deductions
There are provisions for allowable deductions when a property subject to the bright-line test is sold. However, where losses arise as a result of the bright-line test they have been ring-fenced so they may only be offset against taxable gains arising on other land sales. It is not possible to claim a loss arising from a transfer of property to an associated person.
Companies and trusts
Inland Revenue will keep a close eye out for where land-rich companies and trusts try to get round the bright-line test. They may view a transaction as subject to the bright-line test where:
- 50% or more of the shares within a 12-month period are sold
- there is a change in the trust deed
- a decision-maker under the trust deed changes
This applies where at least 50% of the value of the company or trust is attributable to residential land either directly or indirectly.
One to watch - related party transactions
With tight restrictions on finance, first home buyers are often forced to find different ways to purchase property. We have heard of several instances where mortgage brokers have recommended that parents purchase the property to get around financing rules and then sell the property to the children when possible.
Depending on the factors, these sales may be caught by bright-line rules and therefore any profits on the property become taxable. Note that it is not acceptable to purchase and subsequently sell the property at the same price if the value of all the other houses in the area have increased. For taxation purposes, the sale must be at market value.
A Final Note
Regardless of the bright-line rules, when a property has been bought with the firm intention of resale you'll have to pay tax on any profit from the sale.
Please contact us if you are considering buying or selling residential property; your company is thinking about a large scale share transfer; or there are any changes to the family trust’s trust deed or trustees.