What is the bright-line property rule and what does it mean to you?
A ‘bright-line rule’ is a clear and defined rule, like a line in the sand, that leaves no room for interpretation. The bright-line rule you are most likely to have heard of is the bright-line property rule.
What is the bright-line property rule?
The bright-line property rule means that if you sell a residential property you might need to pay income tax on any gains. How it works depends on when the property was bought.
When does the clock start ticking?
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) - NOT the day you sign the Contract.
Different dates apply if you sell the land before your purchase was registered with LINZ, if you bought the land because of a subdivision of property (for example as a sale “off the plan”), or if the property is purchased in another country.
Are there exclusions?
There are some situations where the bright-line rule does not apply:
Exclusion 1 - Main home
If the property is the family/main home it will be excluded. Your main home is the property you have the greatest connection to. To be eligible for the main home exclusion to the bright-line rule, you need to have used a property as your main home for more than 50% 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 gardens and related buildings like the garage).
If you live in more than one property, you’ll need to decide which is your main home as you can only have one. Also, you can only use the main home exclusion 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 would not be eligible for the main home exclusion.
You’re also not eligible for the main home exclusion if you show a regular pattern of buying and selling residential property.
Residential properties held in trust can use the main home exclusion under the bright-line rule if:
Exclusion 2 - Inherited Property
If the residential property was inherited, or if the seller is the executor or administrator of a deceased estate then the property is excluded.
Exclusion 3 – Property (Relationship) Act settlement
If you receive a property as part of a relationship settlement agreement, you will not 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.
What are the tax implications of the bright-line property rule?
If you sell a property that falls under the bright-line property rule, you will need to submit an income tax return and a property sale information form - IR833 at the end of the relevant tax year.
Residential land withholding tax (RLWT) will apply to your property sale if:
a) the property sold is in New Zealand and defined as residential land, and
b) the seller:
What if the property is sold at a loss?
If a residential property that the bright-line rule applies to is sold at a loss (and no exclusions apply), these losses are “ring-fenced” as to residential property sales so that 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.
What about non-residential property?
The bright-line rule only applies to residential property. A property is not residential if it’s mainly used for business or as farmland. That means when you sell farmland or business property, the bright-line rule will not apply. But you’ll still need to follow existing tax rules.
Also, 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. This is called the ‘intention test’. The intention test is not a new rule. It’s been around for a long time.
A final word
If you sell a residential property outside of the relevant bright-line period for you, the bright-line rule will not apply to your property sale. But the intention test may still apply.
Remember, all existing property tax rules still apply. So even if the bright-line rule does not apply in your situation, that does not necessarily mean you will not need to pay tax on your property profits.
Please note: This article is designed to provide general information regarding the subject matter covered. It is not intended to serve as legal or taxation advice related to individual situations and cannot be relied on as such. Because each individual's legal situation is different, specific advice should be tailored to the particular circumstances.
Trish likes to do her thinking while she drives - what a perfect combination for a mobile lawyer!
This blog shares those thoughts.
Subscribe for more information and feel free to share your views.