Property Tax Changes ...
Labour is making good on its election policies with tax changes introduced in March that are aimed at increasing housing affordability.
Bright-line test extended to 5 years
The first change being the (much anticipated) extension of the residential bright line test from 2 years to 5 years.
Intention of bright-line rule – buying for resale always taxable
The bright-line test you may recall, was introduced to tighten up the existing land taxing provisions. If you purchase land with the intention of disposing of it, you will (and always were) subject to tax on the gain.
The problem with this rule is that it was fairly difficult for the IRD to prove that you held such an intention where property is bought and sold within a short period of time, and you had a halfway reasonable excuse for your change in intention. Given the government and public concerns around affordability of housing, property speculators, and the much publicised property “flipping” transactions, the bright-line rule was introduced to provide a definite line in the sand as to when you will be taxed, irrespective of your stated intention for the land. This original “line in the sand” period was 2 years.
Extension of test to 5 years – beware of technical “date of acquisition”
Under the new rule, residential land purchased on or after 29 March 2018 will be subject to tax if it is disposed of within 5 years of acquisition, instead of the previous 2 years. Technically, you have purchased on or after 29 March 2018 where you have acquired your “first interest” in the land – this is generally the date there is a binding agreement (i.e. unconditional date), however there are special rules for purchases such as land bought off the plans and land to be subdivided.
Note that the test for whether you are subject to the 5 year rule (or the 2 year rule) may be different to your “acquisition date” for determining whether you have bought or sold within a 5 year period. The exceptions to the bright-line rule are where the land is your main home, farm land or a business premises.
Extended rules will have a wide reach – possibly wider than original intention of bright-line rule
We anticipate this change will have a far wider impact on our clients, particularly those who experience an unexpected change in circumstances. There could be any number of reasons for this – a loss of income/redundancy or a bad experience with tenants are two issues that spring to mind which may trigger an unexpected sale.
The rationale in extending the bright line from 2 years to 5 years is to “crack down on speculators” and the rules are intended to target speculators who buy houses with the aim of making a quick capital gain. While there is no doubt there are those who intend to make a quick gain by buying and selling property within 5 years, the rules will also apply to those who have a genuine long term investment intention and experience an unexpected change in circumstances.
Unfortunately, the bright-line test makes no distinction and will tax the gain in both scenarios. This is the problem with introducing a rule that looks like a capital gains tax and smells like a capital gains tax, but isn’t a capital gains tax - however that is a topic for another day!
If you think you may be subject to the bright-line test, or you would like advice with planning for the future, please contact us we would be happy to assist.
Ring fencing of rental losses coming
The second change is an issues paper which proposes to ring-fence rental losses. Again, this was a change signalled in Labour’s election campaign. The issues paper proposes at a high level that:
- The loss ring-fencing rules will apply to “residential land”- the same definition that applies for the bright-line test will apply to the ring-fencing rules.
- The rules will not apply to your main home, a property that is already subject to the mixed use asset rules (i.e. a family bach) and land that is on revenue account.
- It is proposed that the loss ring-fencing rules will apply on a portfolio basis, so you (fortunately) won’t have to calculate whether ring-fencing applies on a property by property basis.
- Ring fenced losses will be able to be offset from future residential rental income (from any property) and taxable income on the sale of any residential land.
- Rules will be introduced to ensure you can’t circumvent the ring-fencing rules by interposing other entities – essentially income from investments in “land rich” entities will be treated as income from residential rental.
Ring fencing to start from 1 April 2019
It is proposed that the ring-fencing rules will apply from the start of the 2020 income year – so from 1 April 2019 for March balance dates. IRD are seeking feedback as to whether the ring fencing rules should be phased in over 2 years or introduced in full from 2020, noting that it is more complicated to phase the rules in and tax legislation is not normally phased in.
Phasing in over 5 years scrapped
Labour’s election policy stated that any ring fencing of rental losses would be phased in over 5 years so those affected would only suffer a 20% impact each year. We are now dealing with a potential phase in of only 2 years, or none at all. The other worrying aspect of these rules is the short implementation period – we have seen significant issues arising in the past when legislation is rushed through, however it will be a case of having to wait and see at this point.
The proposals are at an issues paper stage only, and with most things in tax - the devil is in the detail. We will have a better idea of exactly how the rules will work once the government releases draft legislation, so watch this space for further developments, however if you would like to discuss how the proposed rules will affect you, please contact us for further advice, we would be pleased to assist.