Do I Have To Pay Tax Under the Bright Line Test?

Introduction

In New Zealand, we have an intention-based tax system for property.

If you buy a property intending profits to come from capital gains – then you'll pay tax on those capital gains.

If you purchase a property but don't intend to sell it for capital gains – instead using rent as your primary source of income – then any growth in the property's value is not taxed.

Of course, your initial intention when buying a property is hard to prove. That's why we now have a Bright Line Test, where the gains from some property purchases are taxed as income.

This article breaks down what the Bright Line Test is and who it applies to. We'll also cover a few situations where Kiwis often get caught out and have to pay tax on their property sales, even when they don't think they have to.

 
History of Bright Line

History of the Bright Line Test – NZ's lite-capital gains tax

In New Zealand, we don't have an official capital gains tax. However, that doesn't mean all capital gains are tax-free.

In 2015, John Key's National government introduced the Bright Line Test. This legislation tightened property investment rules and made some capital gains taxable.

If you sold a property within two years of buying it, you had to pay for any capital gain as income.

You then pay tax on that gain at your income tax rate. That means the tax paid can differ for each person depending on how much they already earn.

For instance, if you already pay the top tax rate because your income is above $70,000, you would then pay 33% in tax on any gains from property.

The Bright Line Test was expanded in 2018 under Jacinda Ardern's Labour government, where the test is now 5 years. So if you sell a property – other than your primary home – within 5 years, you will pay tax on any gains made.

Right now, there is speculation that the government may extend the Bright Line Test out further to 10 years.

How It's Calculated

How is the tax I have to pay calculated?

The Bright Line Test calculates your net gain from a property transaction.

So if you buy an investment property for $400k and sell it for $500k 3 years later, you're unlikely to pay tax on the entire $100k difference.

That's because it's likely 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 to the property
  • Potentially buyers-agent fees when you purchased the property.

The leftover amount is then added to your current income, which you then pay tax on at your income tax rate.

For example, say you purchased a property for $400k in Dunedin 3 years ago. Once you acquired the property, you spent $40k renovating it, which increased its value. You then sold it for $550k today, attracting real estate fees of $25k.

There is a $150,000 difference between what you spent when purchasing the property and then what you sold it for. But, to make that happen, you spent $65,000 renovating and selling it.

This means you'll only pay tax on the remaining $85,000.

If you earn $70,000 in salary and wages your tax rate for any extra income is 33%.

That means that 33% of that $85k will be paid as tax – $28,050. You will then 'take-home' $56,950.

Who Doesn't Have To Pay

Who the Bright Line Test does not apply to

The Bright Line Test intends to target short-term property investors. That's why it doesn't apply to your main home.

That means you can buy and sell the main home you live in without having to pay tax.

However, you can only have one main home. That means that if you buy a holiday home and sell it within 5 years, you'll pay income tax on any net gain.

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 all choose to sell it, you don't have to pay tax on any of it.

And, of course, if you buy a property and sell it over 5 years later, you will also not pay any tax on the gains you have made, even if it was an investment property.

However, you may need to pay income tax on your capital gains in some instances even if you meet the above criteria.

This will generally be the case if you or someone close to you is involved in property trading, development or buying-and-flipping.

In this case, you'll be doing yourself a favour if you get advice from a property accountant on 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 after you've already used the money from a sale for something else.

Who Has To Pay

Who still has to pay tax under the Bright Line Test?

If you sell a property within 5 years of buying it and the property isn't:

  • Your main home, or
  • An inherited property

Then you clearly need to pay income tax on any gain you've made.

But, even if you sell an investment property or holiday home more than 5 years after purchasing it, you may still have to pay tax.

This can happen in a few ways.

Firstly, if your initial intention was to make a capital gain on a property, you will always need to pay tax no matter how long you hold it.

Secondly, if you or someone close to you is involved with property trading, then the test for you is 10 years instead of 5.

For instance, let's say that you're a builder. As part of your property investment strategy, you purchase real estate to buy-and-flip (sell quickly) and buy-and-hold.

Because the IRD considers you to be in the business of property dealing, you need to pay tax on the gains from any property you sell within 10 years.

That includes if you sell any of your buy-and-hold properties where your primary source of income was meant to be from rent rather than capital gains.

In this case, while you are involved in the business of property dealing, all your properties will be tainted. That means your gains will be taxed if you sell the property within 10 years.

This also extends to any properties that:

  • Your partner or spouse owns
  • Your children own (if they're under 20)
  • Are owned by a company that you own 25%+ of the shares in
  • Are owned by a company that your partner owns 25%+ of the shares in
  • Are owned by a company that your children own 25%+ of the shares in (if they're under 20).

This is called the Associated Persons rule, which means that anyone close to you also has to pay tax if they sell a property within 10 years and make a gain.

The rule's purpose is to stop people who deal in property 'structuring out' of paying tax.

Without this rule, you could trade property under your partner or children's names to get around the IRD's rules and pay less tax.

People who had to pay

Examples of people who accidentally had to pay tax

Even with the best intentions, Kiwis can get themselves into situations where – without meaning to – they have to pay tax.

Here are three examples:

 



Repeatedly buying and selling when it's your main home

If you buy and sell your main home within 5 years, you aren't captured under the Bright Line.

But you can only use the main home exemption twice in any two-year period.

If you establish a pattern of buying and selling your main home, the IRD considers that your intention was always to buy and sell for profit.

Because that was your intention you then need to pay tax.

For example, you buy a home to renovate and live there while doing-up the property.

Three months later the property is renovated and is now worth more, so you sell it. You made $50,000 on the property, which isn't taxed because you use the main-home exemption.

That seemed to work, so you do it again. You buy a property on the other side of town, making it your main home.

This time you take 6 months to renovate the property. You then sell it and make an $80,000 gain. You don't pay tax because you claim the main-home exemption.

You're on a roll, so you attempt to do the same again. You buy a property, renovate it, sell it after 3 months and make a $40,000 gain. You don't pay tax.

You then get a call from the IRD, asking for their cut of the $40,000 you just made.

They tell you that the government considers that your intention was never to make the third property your main home. Because they believe your purpose was to create a capital gain, you need to pay tax on the $40k income, and you need to pay them $13,200.

The key message here? If you establish a pattern of buying and selling your main home in a short space of time, it is likely you will need to pay income tax on your gains.

Moving properties between entities

The next area where property investors get caught out and need to pay tax on their property transactions is when properties are moved between entities.

For instance, a standard tax-minimisation tactic is to sell a property from an investor's own name into a look-through company they also own (or into a family trust).

But, if you sell an investment property from your own name to a look-through company, you can still be caught under the Bright Line Test.

It doesn't matter that you own the company or are related to the trust you're selling the property into. In the IRD's eyes, the property is still changing hands.

Let's take another example.

You buy an investment property for $500k. Three years later, you want to refinance the property by selling it to a look-through company to reduce your tax. You sell it to yourself for $600k.

Because you sold the property within 5 years of acquiring it, you need to pay tax on the perceived capital gain of $100k.

This is why property investors will wait until the 5-year Bright Line period has expired before moving properties between entities they control.



Resetting of the Bright Line period

Property investors also need to be aware that once a property is sold to another entity – even if you control it – the Bright Line period resets.

For our third example, let's say you bought an investment property in 2014 and sold it to a look-through company you own in 2019.

You won't have paid tax when you sold it into the look-through company since you purchased it before Bright Line Tests were introduced.

However, because the property has now changed hands the Bright Line Test resets … even though you have – in effect – just sold it to yourself.

This means that you now need to wait another 5 years – until 2024 – before you can sell the property and not pay income tax on recent capital gains.

Conclusion

What are the main takeaways from this article?

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

There are rules, and then there are exemptions to those rules. And then there are how those rules are interpreted in particular situations.

Because we work with property investors worldwide, here at Opes Partners we often see how varied investors’ personal situations are.

That's why you must consult a property tax accountant and property lawyer when you enter property transactions.

If you are looking for a property accountant, then check out our list of top 5 property accountants in NZ, along with the types of investors they are suitable for.

Frequently Asked Questions

Your top questions about the Bright Line Test answered

Question: How many years is the Bright Line Test right now?

5 years.



Question: What tax rate will I pay?

You pay your marginal income tax rate.

If you earn $100,000 in salary, your marginal tax rate is 33%. If you then make a $50,000 gain through a property sale, this will be taxed at 33%.

If, instead, your salary is $50,000, your marginal tax rate is split. You'll pay 30% tax for any income you earn up to $70,000, and 33% for anything after that.

If you make a $50,000 gain through a property sale, the first $20,000 will be taxed at 30%, and the other $30,000 will be taxed at 33%.



Question: Does the Bright Line Test apply to all property?

No. The Bright Line Test only applies to residential property. It does not apply to commercial property or farmland.

It also doesn't apply to your main home, relationship property, or inherited property.

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Want To Learn More About Property Taxes?

If you're keen to learn more about property tax, then check out these articles: Where Are The Cheapest Local Council Rates For Property Investors?; Will We See a Capital Gains Tax in NZ?; The Top 5 Property Accountants in NZ; and A Guide To Interest Deductibility.