Do I have to pay tax under the bright line test in NZ?

The bright-line test is a way to tax the profit made from buying and selling property quickly. It’s New Zealand’s lite version of a Capital Gains Tax.

Right now, the bright-line test is 10 years. This means, if you buy a residential property and then sell it within 10 years of owning it, you may have to pay tax.

But change is coming. The National-led government has confirmed the bright-line test will go back to two years from July 1, 2024.

In this article, you’ll learn what the bright-line test is and who it applies to. You’ll also learn where Kiwis often get caught out and the changes that are coming.

Quick facts:

• The bright-line test is New Zealand’s version of a capital gains tax.
• National will reduce the bright-line test back to two years from July 1, 2024
• If you sell your property quickly (and it has increased in value), you may have to pay tax
• Whether you have to pay tax depends on how long you’ve owned the property
• There are exceptions to these rules, which we’ll cover in this article below.

What is the bright-line test?

Just because New Zealand doesn’t have an official Capital Gains Tax ... doesn’t mean all capital gains are tax-free.

We have an intention-based tax system for property. This means if you buy a property and intend to profit from capital gains, you’ll pay tax on any value increase.

You’re probably thinking: “But how do they prove I intended to profit from the capital gains?”

You’re right. Your initial intention when buying a property is hard to prove.

This is why we have a bright-line test. It was first introduced by John Key’s National government in 2015.

At that stage, if you sold a property within two years of buying, you had to pay tax on any capital gain.

Three years later, Labour extended the bright-line test to five years. Then, in 2021, they extended it again to 10 years.

National now plans to reduce the bright-line test back to two years from July 1, 2024.

This shorter bright-line test applies to all properties no matter when you bought them. It’s not just properties bought after July 1.

If you currently have a five or 10-year bright-line test, it will go down to two years.

What are the current rules (right now)?

At the time of writing (April, 2024), the length of your bright-line test is based on when you bought and sold.

• • For properties bought after March 27 2021, your bright-line test is usually 10 years
  • But, if you bought a New Build, your test is five years
  • For properties bought between March 29, 2018 and March 27, 2021, your bright-line test is five years
  • For any properties bought before March 28 2018, the bright-line test no longer applies.

That will change in July when National implements its new policy. Every property will have a two-year bright-line test.

So, if your current test is a five or 10-year bright-line, it will go down to two years.

Let's say “Jack” bought a property in June 2022. Under previous rules, Jack could get a hefty tax bill if he sold before June 2032.

But when the test changes, Jack’s bright-line expires in June 2024. Eight years earlier.

More from Opes Partners:

• How do I pay less tax on my investment properties? (Article)
• What is interest deductibility, and why do property investors have to pay more tax? (Article)
• Investor saves $56k by using this 1 bright line test quirk (Podcast)

How much tax do you pay under bright-line?

How much tax you pay (as a percentage) changes for each person. That’s because, under the bright-line test, you pay tax at your income tax rate.

New Zealand has a progressive tax system.

If you make more money, you pay a higher percentage of your income in taxes.

For instance, if you already pay the top tax rate because your income is above $180,000 ... you would then pay 39% in tax on any gains from property.

But if you earn $50,000 from your job, your tax rate is lower. So, you’ll pay less tax.

How is the tax I pay calculated?

The bright-line test calculates your net gain from a property transaction.

Let’s say you buy an investment property for $400k. Then you sell it for $500k three years later.

You made $100k, but you probably won’t pay tax on the entire gain. That’s because you’ll have incurred other costs like:

• Real estate agent fees when you sold the property
• The cost of renovations if you’ve made any improvements
• Potentially buyers’ agent fees when you purchased the property
• All of these costs are deducted from your gains.

The leftover amount is added to your income, and you pay tax as normal. Let’s go through an example.

Bobbie purchased a property for $400k in Dunedin three years ago. She then spent $40k renovating it, which increased its value.

Later, she sold it for $550k, attracting real estate fees of $25k.

She sold the property for $150,000 more than she bought it for. But she’s spent $65,000 renovating and selling it.

This means Bobbie only pays tax on the remaining $85,000 ($150,000 minus $65,000).

Because she earns $70,000 in salary, her tax rate for any extra income is 33 per cent.

That means 33 per cent of that $85k will be paid as tax – $28,050.

Her “take home” money is now $56,950.

What does the bright-line test not apply to?

The bright-line test doesn’t apply to every property. Here are the properties the test does not apply to:

#1 Your main home

The bright-line test intends to target short-term property speculators. That’s why it generally doesn’t apply to your main home. That means you can buy and sell your main home without paying taxes.

But you can only have one main home. That means if you buy a holiday home and sell it within the bright-line period, you’ll pay income tax on any net gain.

On top of this if you’ve ever rented out your own house, even for a short time, you may still have to pay the bright-line test. More on this below.

#2 Properties bought before February 2018

At the time of writing, if you bought your property before February 2018, you won’t have to pay tax under the bright line. The test either:

• has never applied to you or
• doesn’t apply any more (because the time frame has run out).

Once the rules change, if you bought your property before July 2022, you will then be outside the bright line.

#3 Inherited property

The bright-line test also doesn’t cover inherited property.

If a parent dies and leaves the property to you and your siblings and you sell you don’t have to pay tax on any of it.

Again, there are some intricacies. We’ll discuss below.

#4 If you hold the property for more than your bright-line test (currently 10 years)

And, of course, if you buy a property and sell it over 10 years later you will also not pay tax on the gains. This is true, even if it was an investment property.

Who still has to pay tax under the bright-line test?

If you sell a property within the bright line and the property isn’t:

• Your main home, or
• An inherited property.

Then you need to pay income tax on any gain you’ve made, but there are other fishhooks.

Here are a few examples where people accidentally had to pay under the bright-line test:

#1 Repeatedly buying and selling when it’s your main home 

Bob and Billy are gung-ho renovations-focused investors. 

Recently, they’ve been buying houses, living in them, and selling for a profit. 

They’re taking advantage of the rules where you don’t have to pay tax on your main home. 

For instance, they bought a cheap house that needed some love. They lived there during the renovations and sold it for a $50,000 gain within three months. 

Since it was classed as their “main residence”, Billy and Bob didn’t pay tax. 

But while your main home is exempt … you can only use the exemption twice within two years. 

This means as Bob and Billy continued buying and selling “their own home”, the IRD soon began to notice. 

For their second property, Billy spent six months renovating it and sold it for an $80,000 gain. Again, they avoided tax by using the main home exemption. 

Then, they bought another property, renovated it, and sold it within three months. 

They made a $40,000 gain. However, this time they received an unexpected call from the IRD, demanding their share of the profit. 

The IRD said their pattern of buying and selling properties indicated a profit-making intention, which meant they were now liable for taxes on their gains. 

So, Bob and Billy were required to pay taxes on the $40,000 they made on their last property. With a tax rate of 33%, they owed the IRD $13,200.

#2 Turning your home into a rental

Before the 2021 changes to the bright-line test, a property was your main home if you lived in it more than 50% of the time.

So, if you lived in it for 2.5 years and rented it out for 1.5 years, you wouldn’t have to pay any tax. This is no longer the case.

It’s called the “change-of-use” rule. If an owner chooses not to live in the property for over 12 months the “main home exemption” doesn’t fully apply to you.

Let's say Jo has a property that has a 10-year bright-line test. But she chose to rent out the property for two years while she was on her OE.

She decided to sell the property after owning it for six years.

Since it was a rental for a third of the time, she had to pay tax on a third of the gain.

Put simply, she will now pay tax on the two years it was a rental.

#3 Moving properties between entities

Property investors often get caught when properties are moved between entities.

Investors usually sell their property between entities (e.g. trusts and companies) when trying to minimise their tax.

For example, an investor might sell a property from their own name into a Look-Through Company. But you can still be caught under the bright-line test this way.

Rob bought an investment property for $500k. Three years later, he wants to refinance by selling it to a Look-Through Company. Rob sells it to himself for $600k.

Because he sold within 10 years, he still needs to pay tax on the perceived capital gain of $100k.

It doesn’t matter that Rob owns the company. In the IRD’s eyes, the property is still changing hands.

This is why property investors often wait until the bright-line period has expired. Then, they move properties between entities.

#4 Resetting the bright-line period

Let’s say you want to transfer a property from your own name to your family trust.

You’re outside the bright-line test, so you didn’t get caught like Rob did in the previous example.

But that resets the bright-line test.

Let’s say you bought an investment property in 2016 and sold it to your family trust in 2021.

You’re outside the bright-line test, so you don’t pay tax. But because the property has now changed hands, the bright-line test resets.

Yes, even though you have – in effect – just sold it to yourself. This means you now need to wait another 10 years before you are outside the bright-line.

#5 Developers, builders and traders

Developers, property traders and builders all get tougher rules under the bright-line test. They are “tainted”.

So if you are involved with:

• property trading
• development or
• buying-and-flipping

You may still need to pay tax on your capital gains (even if you are outside the normal bright-line test).

In this case, do yourself a favour and talk to a property accountant. Ask them whether you need to pay tax on your property sales. You don’t want to receive a call from the IRD asking you to pay a 5-figure tax bill.

What are the main takeaways from this article?

This article will give you a sense of how complicated property tax can be in New Zealand.

There are rules, and then there are exemptions (and exceptions) to those rules. And then there is how those rules are interpreted. This is why you must consult a property tax accountant and lawyer when buying property.

If you are looking for a property accountant, you might like to talk to our team at Opes Mortgages.