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Capital Gains Tax on Rental Properties

In its attempt to slow down the runaway property market, the National Government’s first official foray into a capital gains tax on land became law back in October 2015. Even 18 months on, some unsuspecting property owners are finding themselves unexpectedly caught by the new rules.

Called the bright line test,  the new legislation sought to essentially tax the sale of investment properties sold within two years of acquisition. Main homes are exempt, as are main family homes owned by trusts (subject to a few other minor requirements being met).

You would think that so recently after being enacted, the legislation would hardly have had any application, but you’d be wrong. We have been inundated with queries from our clients who, because of the booming property market, are inadvertently getting caught by these new rules.

Conceptually, we have no problem with a tax arising from short term property holds. If you are turning over investment properties but not doing so with the frequency to be deemed a ‘dealer’, then requiring owners to commit to holding property for at least two years to avoid income tax makes some sense to us. The problem with the new Bright Line rules is they are not particularly sophisticated, so they are catching unsuspecting Kiwis.

A case in point we came across a few weeks ago involved a woman who had acquired a rental property some 20 years ago. 10 years ago she married and it was her intention that her husband acquired half of her assets, and she, half of his. The ownership of the rental property remained in the wife’s name on the basis that the husband essentially owned half of it by operation of the relationship property legislation. In February 2016 the couple finally got around to tidying up the ownership of their assets and together with other matrimonial assets, half of the rental property was correctly transferred to the husband. This was formally recorded on the title.

Between February and June 2016 house prices in Wellington skyrocketed. The couple received an unsolicited offer for the rental property at twice what they thought it was worth. The property was duly sold in July. Even though the husband and wife had owned the property for at least ten years, unfortunately the husband’s half failed the Bright Line Test and was therefore taxable. This was because he had only legally acquired it in February 2016, and it had been sold within two years of that date.

A ridiculous and nonsense result you will agree? We certainly do. However, the reading of the black letter of the law meant the husband had acquired the house after 1 October 2015 (tick), and it had been sold within two years of acquisition (tick). The trick is, if you are thinking about selling any property other than your main home, take advice.

What’s more, the property doesn’t even have to exist before it can be taxable under these new quasi capital gains tax rules.

Another unsuspecting couple bought a new home in a residential apartment ‘off the plans’ in December 2015 for $570,000, which was to be their main home. For the purposes of the Bright Line rules, where property is bought off the plans, the two year time frame starts ticking from the time the sale and purchase agreement is entered into.

The apartment complex development is now fully sold, and whilst the property is only half built, our couple received an offer of $770,000 to take them out of the contract, and accepted it.

At the time they entered into the contract, the couple had no intention to sell it, however, for the Bright Line exemption to apply, the property must have been “used predominately for most of the time…………….as their main home”. That was obviously impossible as it wasn’t even built at that point. The couple’s main home during the period of construction was their rented house in the city. So, in this case, the couple need to find income tax on the $200,000 profit earned.

Possibly a ridiculous and unintended result from the simple application of the legislation.

The purpose of these new capital gains rules is to combat those who buy and sell investment properties for a profit and, to us, that’s fair enough. The new Bright Line Test was clearly introduced to find a simpler way to apply the often complex land taxing provisions – property acquired for the purpose of sale is a hard one for IRD to win; and arguing that a person is carrying on the business of dealing in land can be even more difficult.

The simple message is; don’t sell any property other than your main home that you have lived in for at least half the time you have owned it, without first talking with a Staples Rodway Tax Adviser.