Preserving capital gains: how to stay clear of the Bright-line test
NOTE: for general information purposes only. We recommend professional advice to ensure you are working with the most up-to-date information tailored to your situation. If you need financial advice please contact us. Our friendly team of qualified Financial Advisors are here to help.
When property taxes became a thing in New Zealand, we all started hearing a new and confusing term: the Bright-line test. What is it? What does it mean for your next property sale?
The Bright-line test is the criteria that decides whether you’ll get a tax bill the next time one of your properties goes under the hammer. It also decides whether the family home is exempt.
At first, it largely targeted people who made their money flipping houses quickly. It penalised anyone who sold an investment property within two years. Then two years became five, and now in most cases it’s a decade.
If your next sale falls within the Bright-line criteria, you can expect to pay income tax on any capital gain (the difference between what you paid and what it sells for). Because property sales result in large, infrequent cash boosts, that can push your income for the year into a more penalising tax bracket, or even to the new top rate of 39%. That’s a big bite.
HAVE YOU OWNED IT LONG ENOUGH?
Before you hit go on your Trademe listing, the first question you need to answer is this: when did you buy it?
If it was before 29 March 2018, you’re in the clear. The Bright-line period has either lapsed or it isn’t subject to the test. You can sell it whenever you like and won’t pay any tax, even if it’s clearly an investment property.
If you bought it between 29 March 2018 and 26 March 2021, you’ll need to hang onto it for a minimum of five years.
If you bought it on 27 March 2021 or later, you’ll need to hang onto it for 10 years.
If it was a new build when you bought it, retrospective legislation will soon be introduced to make it five years. We’re still awaiting clarity on what the government considers a new build.
THE FAMILY HOME
If it’s officially your main home, it’s exempted. You could buy today and sell tomorrow and won’t pay any tax.
But what makes it officially your main home? If you live in one place and don’t rent out any part of it, you’re safe. If things aren’t so cut-and-dry, it gets complicated.
First, you can only count one property as a main home. If you normally pinball between two locations, for example, you’re going to have to pick one, and wait until the Bright-line period lapses on the other. It’s also has to look like a main home on paper, in terms of belongings, proximity to work, and so forth.
Also, at least 50% of the property needs to function as your main home. Strictly speaking, if you always Airbnb the house and live in the granny flat out the back, it will be viewed as an investment property and will be subject to tax if you haven’t owned it long enough.
If you own the property as a trustee, don’t worry, it should still be viewed as your main home for tax purposes as long as beneficiaries of the trust live there, but we recommend checking the other conditions on the IRD website.
However, there are exceptions to the exceptions! If you have a ‘pattern’ of selling your main home, you will still end up being taxed. What counts as a pattern? That’s another grey area, and is up to the IRD’s discretion. So if you really are going to buy today and sell tomorrow, maybe make it a one-off.
The IRD also says your home won’t be exempted if you’ve already used the main home exemption twice in the last two years.
What about inherited property? In short, this won’t, be taxed, but again, it gets complicated. If you inherit a house alone you’re fine, but what if it’s pledged to multiple people, such as siblings?
In that case, the siblings can sell their shares, tax-free, to one remaining beneficiary, say, the brother or sister who wants to do it up and rent it out for a while. However, that beneficiary now owns the property by means other than inheritance alone, now that the other beneficiaries have sold it to him or her. Now it’s within the Bright-line criteria and if they sell too soon, it will be taxed. In that situation it could be best to hold onto the house together until it’s time to sell, depending on how well you get along!
THE CHANGE-OF-USE RULE
Did you move out of your home and bring renters in, or otherwise switch things around? The change-of-use rule provides some grace so that your property may still get a main home exemption if you want to sell it within the Bright-line period.
The number to remember is 12 months. If you move out of your main home and sell it less than 12 months later, it will be viewed as your main home and you won’t be subject to tax.
What if you went outside 12 months? Tax will apply, but in proportion. For example, if you held onto the house for a total of four years and moved out halfway through, it operated as an investment property for a total of two years. Your 12 month grace period still applies and is not taxed, leaving a total of one year of taxable capital gain.
Rules around property and tax are still evolving. If you buy and sell often, it would be wise to bookmark IRD’s page about the Bright-line test and check it regularly, especially before you list your next property.