More details on the coming capital gains tax on property

A couple of weeks ago, tax officials released an issues paper following up on the “bright-line” test that was announced in the Government Budget in May.  The paper provides greater detail about how the new rules are intended to work.  They will apply to property acquired and sold from 1 October 2015.

The new rules will supplement a long-standing rule that says a person who purchases land with a purpose or intention of disposing of it will be taxed on the sale proceeds.  The main problem with that rule has been its inherent subjectivity.  It can be difficult to work out what was going through someone’s mind when they acquired property.

The proposed bright-line test draws a line in the sand and says that residential property sold within two years of acquisition will be subject to tax.  Sounds simple enough but, like all good tax rules, it’s important to understand the detail.

The bright-line test will only apply to residential land.  This will mean land that has a dwelling or it, or for which there is an arrangement to build a dwelling.  Business premises will be exempted, as will farmland – provided it’s an “economic unit”.  Lifestyle blocks could be caught out.

A key exemption will be for “the main home”.  A person will only be able to have one main home – including situations where a person has another home in a trust they have settled.

While “habitual renovators” may think this protects them, it’s important to remember that the existing “intention” test will still apply and may well operate to tax sales of the main home in such situations.

Property acquired under a relationship property agreement and inherited property is also exempted.  For example, a child who inherits their parent’s rental property will not be subject to tax if they sell it within two years.  These exemptions reflect the fact that the recipient in such situations generally doesn’t have control over what property is transferred to them.

Deductions will be allowed against property sales caught by the new rules.  These will include the cost of the property itself, as well as costs of acquisition and disposal.  Holding costs will be deductible if they meet the current rules for deductibility.  For example, the costs of holding a rental property, such as rates, insurance and interest, will continue to be deductible.  Costs that would otherwise normally be non-deductible and capitalised to the cost of the property (such as improvements) will also be deductible if the property is subject to the bright-line test.

After allowing for deductions, any remaining gain will be taxed at the owner’s marginal rate of tax as ordinary income.  Losses (which are feasible, given the range of allowed deductions) will be ring-fenced and only able to be offset against taxable gains from land sales.  Losses from sales to associates will be non-deductible, to prevent taxpayers taking advantage by realising losses when property values decline by moving assets within the family.

t’s important to understand that the bright-line test does not mean that property held for more than two years will not be subject to tax.  As noted, the existing intention test will still apply, even if it is more difficult to deal with.  And there are plenty of other provisions lurking in the tax rules aimed specifically at property transactions.

Although it’s not buried in complicated formulas (such as the capital gains tax on portfolio holdings of overseas equity investments, which includes euphemistic labels such as “comparative value”), calling this a “bright-line test” does little to disguise what it really is:  a capital gains tax on property sales.

Geordie Hooft is a tax partner at Grant Thornton New Zealand. Opinions expressed in this column are general in nature and are not intended as a recommendation or guidance to any individuals in relations to structuring their tax or finances. Readers should not rely on these opinions and should always seek independent professional advice specific to an individual’s circumstances.