Much has been written in the media about the recently implemented ‘Bright-Line Test’ which has been introduced by the Government as a tax on residential property purchased on or after 1 October 2015. Under the new Legislation if residential property is sold within two years, then the seller may have to pay tax on any gain made.
This article discusses property transactions in general. Property tax can be a grey area and the tax treatment of different property transactions will depend on their individual circumstances.
As an overview four main factors can determine someone’s status as a property buyer for tax purposes:
- The intention when a property is purchased.
- The patterns of previous property transactions.
- Any association to a builder, property dealer or developer.
- The Bright-Line Test for residential property.
These factors then form the basis for three main classifications of property buyers which are treated differently under tax law:
A speculator - buys a property with the intention to resell it at a profit. The property is treated like trading stock and any profit or loss from selling the property is taxable. Speculating can be a simple one off purchase and sale of a property, or can be an ongoing business.
A dealer or trader - is similar to a speculator who buys property for resale. The difference is there is an established regular pattern of buying and selling properties. Once again gains made are taxable.
An investor - is someone who buys a property to generate ongoing rental income and does not have any firm intention to resell the property. The property is treated as a capital asset and any profit or loss from selling the property is treated as a capital gain and not taxable (apart from repaying any depreciation which has been claimed). The rules however may be different (and profits may be taxed) if the investor is associated with any person or entity involved in the business of building, dealing, developing or subdividing land. It is the rules for this type of investor that have changed with the implementation of the Bright Line test (which is discussed later in this article).
The three categories above are not determined by the nature of the property itself, but rather the intention when the property is purchased as well as any previous patterns of property transactions.
Property transactions and the tax consequences do get tricky to deal with as the Inland Revenue Department can argue that property has been purchased with the intention of resale for a profit despite the fact that the property has been rented out for a few years before the property was sold. There is also no set number of properties that someone can have before they become taxable. In some cases the first property bought and sold may be taxable if it is bought for resale. In other cases there could be a number of factors such as having a regular pattern of buying and selling property before property income is taxable. The factors looked at will vary because each taxpayers circumstances are different. For example buying one property every two years may be considered a regular pattern for one individual and not another.
As noted above, having an association with people in certain property related industries can create a tax impact on property transactions, even if the seller is not personally a property dealer, builder or developer. Associated Person rules are quite complex and the IRD uses a number of tests to work out if two persons or entities are associated for land transactions. Generally if you or a family member or your company or trust has an association with a property dealer or developer then this could mean the difference in the gain from the sale of a property being treated as taxable income rather than a non-taxable capital gain.
The Bright Line Test has been brought in by the Government to help curb the property boom which was accentuated by property investors purchasing residential property. In the past where someone buys a property as a rental and sells it at a later date then any capital gain was not taxed. The Bright Line Test now says that any sale within two years is taxable. There are exclusions to the Bright Line Test and these are if the property is the person’s main home, or if the property has been inherited, transferred under a relationship property agreement or if the property has been transferred on the death of a person to the executor of an estate.
As noted above property tax can get very complex and will depend on a number of scenarios. It has been impossible in this article to discuss all of these, but the article is designed to give you an overview of property transactions rather than specific rules. There are also different rules for GST purposes which depend on both the taxpayer and the nature of the property being purchased. In general GST does not apply to residential rental properties, however does apply to property speculators and dealers or property used for short term rentals.
As always the devil is in the detail and if you are ever in doubt regarding your property dealings I would strongly recommend you talk to a tax professional.
by Cheyne Waldron, Bailey Ingham Director.