If you are purchasing or selling residential property, you should be aware of the implications of the newly-introduced Bright-line Test for taxing capital gains. In this article, UHY Haines Norton’s Jim Martin clarifies the rules of the Bright-line Test and the transactions it will apply to.
Under the 2015 Budget, the Government has introduced the “Bright-line” test (“BLT”) for taxing capital gains made on the sale of residential property. The test applies to residential property acquired on or after 1st October 2015.
The Bright-line test is supplementary to the existing “Intention Test”, which makes gains from the sale of real property taxable when purchased with the intention of resale. The apparent difficulty in enforcing the Intention Test lies in its subjectivity, for example in circumstances when a person did not acquire a property with the intention of resale but needs to sell that property due to factors outside of their control. In contrast, the Bright-line test is a deliberately unambiguous objective test – tightly defined and with few exemptions.
Under the Bright-line test, any gains from the sale of residential property bought and sold within a two year period will be deemed as taxable, with the exception of the main family home. The acquisition date is the date the change of Title is registered, and the disposal date is the date the contract of Sale and Purchase is signed.
What Transactions are Caught By the Bright-line Test?
- The sale of a Right to Buy residential land where the time period between the Contract to Buy and the Contract to Sell is less than two years.
- Residential land with a dwelling on it, when sold within a two year period.
- Land with an arrangement to build a dwelling on it, when sold with a two year period (e.g. purchased with a plan for a dwelling).
- Residential land owned by a Trust, when sold within a two year period, where the settlor owns a home in their own name (outside of the Trust).
What Transactions are Exempt From the Bright-line Test?
- Land used predominantly as business premises.
- Farm land capable of being worked as an economic unit.
- The main family home. This is an actual use test rather than the intended use, classified as:
– Having a dwelling on the land; and
– Is occupied mainly as a residence by the owner; and
– The dwelling is the owner’s main home.
However, it should be noted that the Bright-line Test includes a measure that prevents a person from using the main home exclusion if they have already used this exclusion twice in the previous two years.
- Transfers of land under a Relationship Property Agreement. However, the transferee steps into the shoes of the transferor. If, after the transfer, the property is sold and the deemed holding period is less than two years, the Bright-line test rules will deem the gain on sale by the transferee as being taxable.
- Inherited land, defined as land transferred to the estate. The different scenarios of inherited land are treated as follows:
– Deceased → Administrator = at cost, no gain
– Administrator → Beneficiary = at cost, no gain
– Administrator → Purchaser ‘A’ = estate is exempt from the Bright-line test
– Beneficiary → Purchaser ‘A’ = beneficiary is exempt from the Bright-line test
– Purchaser ‘A’ → Next Owner = purchaser ‘A’ will be considered for the Bright-line test
Properties liable for tax under the Bright-line test are eligible for tax deductions under two categories. The first is capital costs, which are deductible in the year of sale. For example, the cost of land and buildings (plus acquisition and disposal costs), and the cost of any capital improvements are all deductible. Inland Revenue uses the renovation cost of a new roof to illustrate an example of a capital improvement. The second category is land holding costs, which are deductible in the year incurred if allowed under normal tax rules, i.e. by matching costs (interest, insurance, rates, repairs, maintenance) with rents. Otherwise these costs are not deductible.
Losses resulting from the sale of residential property liable for the Bright-line test are ring-fenced so they are only deductible against taxable gains from other land sales. These restrictions on losses do not apply to developers and dealers in land.
Current land sale rules do not apply to the sale of shares in a land-rich Company, or the change in the terms of a land-rich Trust (such as changes to a Trust Deed to alter beneficial ownership of land or control of the Trust instead of transferring the land). A rule has been proposed to prevent avoidance of the Bright-line test’s application through the use of Companies and Trusts.