Like most property owners you have probably heard about the bright-line test but not necessarily understood how and when it could apply. We have been noticing an increase in queries from clients about how this property rule applies to their own situation.
Put simply, bright-line says people who sell a house in New Zealand within a specified number of years of buying it, must pay income tax on any gains, unless it's their main home or another exception applies. Originally this period was two years and since 29 March 2018 this has increased to five years.
The bright-line rule is a clearly defined rule that leaves no room for interpretation. You can think of it as someone drawing a line in the sand. It's clear when you cross that line.
To help you understand and navigate this relatively new area of property tax rules, below are a range of questions and answers as provided by the IRD.
1. What does "bright-line rule" mean?
The bright-line property rule says you'll pay tax when you buy and sell a residential property within five years, unless an exception applies. It's easy to know if this rule applies in your situation.
All existing property tax rules still apply. So even if the bright-line rule doesn't apply in your situation, that doesn't necessarily mean you won't need to pay tax on your property profits.
2. When does the bright-line rule apply from?
The bright-line rule applies to the sale of any residential property you've bought on or after 1 October 2015 as follows:
- If you bought a residential property 1 October 2015 to 28 March 2018, inclusive: the two- year bright-line rule applies.
- If you bought a residential property on or after 29 March 2018: the five year bright-line rule applies.
But whenever you buy a property intending to resell it, you'll need to pay tax on any profit you make when you sell that property.
3. When does the bright-line period start?
Generally, the bright-line period starts on the date the property title is officially transferred to you, which is the date the property transfer is registered with Land Information New Zealand (LINZ).
If the property is in another country, the bright-line period starts on the date the transfer was registered under that country's laws.
Different dates apply if you sell the land before your purchase was registered with LINZ or if you bought the land as a result of a subdivision of property (for example as a sale "off the plan").
4. What types of property does this rule apply to?
The bright-line rule only applies to residential property.
A property isn't residential if it's mainly used for business or as farmland.
That means when you sell farmland or business property, the bright-line rule won't apply. But you'll still need to follow existing tax rules.
5. What if I sell my property after the relevant bright-line period has ended for me? Do I have to pay tax?
If you sell a property outside of the relevant bright-line period for you, the bright-line rule won't apply to your property sale. But the intention test may still apply.
The intention test says you must pay tax on property profits if you originally bought a property with the intention to resell it. The intention test isn't a new rule. It's been around for a long time.
6. What happens if I make a loss on a property sale, instead of a profit?
If a residential property that the bright-line rule applies to was sold at a loss (and no exceptions apply), these losses would be "ring-fenced".
If you owe income tax on another residential property sale in the future, you can subtract these "ring-fenced" property losses from the income you earned on this later sale. That means you'll pay less tax on the later sale.
7. What if I sell overseas property? Do I have to pay tax in New Zealand?
New Zealand tax residents pay tax in New Zealand on their worldwide income.
If you're a New Zealand tax resident who earned income selling a property in another country, you may need to pay tax there. You'll also include it on your New Zealand income tax return and pay any tax.
There are some exceptions to the bright-line rule (aka when the bright-line rule won't apply to your property sale):
1. What is the main home exception to the bright-line rule?
If you buy and sell your main home, the bright-line rule won't apply. It's an exception to the bright-line rule. It means that you generally won't have to pay tax when you sell your main home.
But you can only use the main home exception twice over any two-year period. You'd have to pay tax on any profit you make from the sale of a third property in two years because you wouldn't be eligible for the main home exception.
You're also not eligible for the main home exception if you show a regular pattern of buying and selling residential property.
2. What does "main home" mean under the bright-line rule?
You could think of your main home as your "family home". Your main home is the property you have the greatest connection to.
To be eligible for the main home exception to the bright-line rule, you need to have used a property as your main home for 50% or more of the time that you've owned it.
You also need to use more than 50% of the area of the property as your main home. (The area that counts as your main home generally includes things like your yard, gardens and related buildings like the garage.)
This is an important point if you rent out a granny flat attached to your house or part of your house is used as a business. As an example, if you use 40% of a property as your home and 60% as a rental property, you can't use the main home exception if you sell that property.
If you live in more than one property, you'll need to decide which is your main home. To decide if a property you own qualifies as your main home, think about:
- Where your personal property is kept
The amount of time you spend living in each house
Where your immediate family lives
Where your social ties are strongest
Your use of the home
What other ties (for example: employment, business, economic) you have with the community.
3. Who decides if the main home exception applies to me?
The person selling a property decides if it's their main home. You'll do that based on the criteria listed above.
4. Can I have more than one main home?
No, you can only have one main home.
If you live in more than one house, your main home is the one that you have the greatest connection to. You'll find the criteria for deciding which property is your main home listed above.
5. My main home is held in trust. Am I eligible for the main home exception if I sell it?
Residential properties held in trust can use the main home exception under the bright-line rule if:
- The house sold was the main home of the principal settlor of the trust, or the principal settlor didn't have a main home, and
- It was the main home of a beneficiary of the trust.
The principal settlor of a trust means the settlor whose settlements to the trust have been greatest by market value. In other words, the principal settlor is the person who has made the biggest financial contribution to the trust.
6. What if I inherit a property? Does the bright-line rule apply to me?
The bright-line rule does not apply if you sell a property you inherited.
7. What if I received a property as a part of a relationship break-up? Does the bright-line rule apply to me?
If you receive a property as part of a relationship settlement agreement, you won't need to pay income tax on the property when it's transferred to you.
However, if you go on to sell this property within the bright-line period for this property, the relevant bright-line rule will apply.
Reference: IRD website
As indicated by the IRD, many aspects of bright-line depend on your personal circumstances and hence it is very important that you discuss these with us so we can advise you appropriately. For more information and to discuss whether bright-line applies to you, please contact us for an appointment today.