8 March 2018

Wait Five Years, or Pay Tax

Changes to the property Bright Line Test are imminent. What are they and how could it affect you?


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As early as the end of this month, the Bright Line Test (BLT), brought in by the previous government to dampen property speculation will be extended from two years to five years.

This means that any residential land sold within that period will be liable for income tax on any profits made, regardless of the reason for which it was purchased. An exemption exists for a taxpayer’s principal residence – however, second homes, residential rental properties, even vacant residential sections are included. Even the intention to live in the house won’t be enough to be exempt, you have to actually live there.

For many, this three-year extension has come as a bit of a shock, say Mark Withers, Partner at Ponsonby-based Accountancy firm, Withers Tsang. “For most people, two years was manageable, but a lot can happen in a family’s circumstances over a five-year period, so we foresee many more situations where residential properties will be caught by the BLT once that test spans five years of ownership." You will definitely need to keep the acquisition date under a fridge magnet to beat this one,” he says.

Whether a property acquisition will be on the two-year side of the law or the five-year side of the law will be determined by when you ‘first acquired an interest in the land’. This ‘first interest’ is gained when you have a sale and purchase agreement signed, so any agreement entered into to acquire residential land before the new legislation receives its royal ascent and passes into law will fall under the existing law and be subject only to a two year BLT.

Withers goes onto explain that the introduction of the Bright Line Test was a government initiative that recognised that the existing law around buying and selling property with an ‘intention to dispose’ was collecting no tax.

“It was all too easy for property owners to find a reason to sell a property, other than for profit – which would have incurred a tax,” he says. “So the Bright Line Test gives some teeth to the ‘intention’ provisions that had been completely ineffective up until this point.” Withers warns though that the original intention provisions remain and have no time limit. The BLT simply removes all debate about the reason for the acquisition when the sale falls within the day count.

If someone wants to avoid the tax they will simply sit on their property, come what may.

If someone wants to avoid the tax they will simply sit on their property, come what may.

Will it work? Well, that depends on what the government is trying to achieve, says Withers. “It will certainly dampen enthusiasm for speculation, but equally, it was brought in to try and dampen the housing market as a whole. One of the ironies is that if someone wants to avoid the tax they will simply sit on their property, come what may. So in some respects it will tie up properties that would normally be coming back onto the market, restricting numbers and potentially limiting supply. And when supply is limited, prices will inevitably rise.”

“Also, another irony is that if the measure of why this initiative was introduced is successful – that is, to stop people speculating in property – then the government will not collect any tax,” he smiles.

Getting down to the nitty gritty, how does the BLT work in real terms in real-life scenarios? Withers explains…

“For family trusts, if a property is to be exempt from the test under the main home exclusion, then it must be the home that the principal settlor of the trust lives in and has the closest attachment to. For example if mum and dad, as principal settlors of a trust, buy a second house, then make it available to their daughter to live in, then that house would not be exempt [from the BLT] if sold within five years, even though it was the main home of their daughter. Being a beneficiary of the trust is not the same as being its principal settlor.

Similarly, if you borrowed against your primary place of residence to buy a rental, which is a very typical way of doing things, then you then sold your home within five years, it would generally be exempt under the main home exclusion, but if you sold the rental within the [BLT] period, you would be liable for tax on any disposal gain.

Aside from the rules surrounding the BLT there are existing tax laws surrounding profits made from subdividing land. Taxes may apply where land has been developed or subdivided within 10 years of acquisition, when the work involved is ‘more than minor’. Common law has set the bar low when determining whether work is minor. There are limited exemptions from the taxing provisions that apply, but they include development or subdivision of a taxpayer’s residence. There are also exemptions where the work has been done to derive rental income from the land. However, property investors that subdivide a rental property within 10 years then sell off the section should tread carefully, even if they are outside the [BLT] timeline.”

Properties for sale that enter into a sale and purchase agreement prior to the law change will be subject to only a two year BLT.

Properties for sale that enter into a sale and purchase agreement prior to the law change will be subject to only a two year BLT.

Is the BLT a fair initiative? There is no doubt that the government has tightened the rules on speculators who sought to avoid tax on gains, by renting properties for short periods and selling them on, having claimed no intent to sell them at acquisition. Certainly, something had to be done about this, but Withers argues that property investors seem to have been singled out.

“Speculation is rife in the NZ Stock Market, and existing laws, section CB 4 in fact, say that gains on personal property, which includes shares, are taxable where acquired for disposal. But there isn’t even a murmur from the government or the public that the laws taxing profits from selling shares should be enforced, let alone strengthened, yet the property investor is put under the microscope. Where’s the fairness in that?” he says. “By imposing a Bright Line Test on a specific asset class, you are distorting the way people are choosing to invest, or should I say, speculate that will be an unintended consequence of this legislation.”

Withers goes on to say that this was a politically motivated change. “It ticked a box that allowed the government of the time to say they were doing something about property speculation. It is not really about collecting tax, tax was just the tool used to modify behaviour in the property sector. If it was, it would have been extended to other forms of investment.”

 

So, what tools will the Inland Revenue use to enforce this legislation? The obvious avenue to pursue would be to check property transactions through the Land Transfer Office then cross reference them to the owners tax returns. “I wouldn’t be at all surprised if we start to see the IRD sending out phishing letters, asking questions about individual property sales on residential properties sold within the five-year period.” The IRD already use this technique successfully to identify regular patterns of buying and selling that could signal someone is in the business of dealing in land.

Philosophical arguments aside, the wheels are in motion and this new measure will be in place within weeks. So, if you have been toying with the idea of another investment property, or debating about the right time to help your kids into a property, or wondering whether it’s worth putting an offer in on that bach, or land banking that section next door, it just might be worth considering getting it on paper now before this law passes.

There is still a window of opportunity to beat the change, but time is of the essence.


Disclaimer
“The information contained in this article is of a general nature and is not purported to be tax advice. Neither the writer, Ray White Damerell Group nor any principal or employee of Withers Tsang & Co Ltd accepts any responsibility to any person seeking to rely on it. Tax outcomes depend upon the application of specific circumstances to the relevant legislation. Anyone requiring specific tax advice relevant to their affairs should seek advice from their professional tax advisor.”

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