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

Last updated: April 1, 2022

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Ed McKnight

Economist, property investor and host of the Property Academy Podcast
Introduction

New Zealand doesn’t technically have a Capital Gains Tax. It sort of does, but it doesn’t.

In a nutshell, if you sell a residential property you have owned in New Zealand for less than 10 years you may have to pay income tax on the gain.

It’s called the Bright-Line property rule, and it’s New Zealand’s lite-version of a Capital Gains Tax.

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

What Is The Bright-Line Test?

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

The way it works is an intention-based tax system for property. This means if you buy a property intending to make profit from capital gains – then you'll pay tax on those capital gains.

If you purchase a property but don't have immediate plans 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 was introduced by John Key's National government in 2015. At that stage, if you sold a property within two years of buying it, you had to pay for any capital gain as income.

You paid 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.

In 2018, the Bright-Line Test period was extended to 5 years while maintaining the other original policy settings.

But then in March 2021, the Government announced the Bright-Line period would be extended to 10 years for residential property acquired on or after March 27 2021.

 
Who Pays

So … What Are The Bright-Line Rules? Who Has To Pay Bright-Line Tax?

What matters with the Bright-Line Test is when you bought the property, and the time that has passed to when you want to sell the property. Because of all the extensions over the years, there are varying periods.

Property owners will have to pay income tax on any capital gain if you:

  • Bought your property on or after March 27 2021, and sell within the 10-year Bright-Line period
  • Bought your property between March 29 2018 and March 26 2021, and sell within the 5-year Bright-Line period
  • Bought your property between October 1 2015 and March 28 2018, and sold within the 2-year Bright-Line period.
Who Doesn't Have To Pay

Who the Bright-Line Test does not apply to?

 

Property Owners pre-2015

If you bought your property prior to October 2015, you don’t need to worry – the Bright-Line Test does not apply to you.

New Builds

While not exempt from the Bright-Line test, any New Builds purchased after March 2021 still only have a 5-year Bright-Line period.

Your Main Home

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 10 years, you'll pay income tax on any net gain.

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

If you hold the property for more than 10 years

And, of course, if you buy a property and sell it over 10 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.

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.

You sold the property for $150,000 more than you bought 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 ($150,000 - $65,000).

Let’s say you earn $70,000 in salary and wages, so 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 Has To Pay

Who Still Has To Pay Tax Under The Bright Line Test?

 

If you sell a property within 10 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 10 years after purchasing it, you may still have to pay tax.

Here are a couple of people who have accidentally had to pay under the Bright-Line Test:

Repeatedly buying and selling when it's your main home

If you buy and sell your main home within 10 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 it up.

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 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.

 
Capital Gains Tax

Will We See A Capital Gains Tax Introduced In New Zealand?

Property investors around New Zealand worry that the government will introduce a capital gains tax (CGT).

On the other side of the social spectrum, some Kiwis worry that the government won’t.

Capital gains taxes are unlikely to be introduced within the short term.

The Prime Minister, Jacinda Ardern, has stated that after trying to introduce a capital gains tax for 9 years, she has had to accept that New Zealanders are not supportive of the tax.

Even popular prime ministers eventually leave office.

Once Ms Ardern relinquishes the prime minister’s office, whether in her own time or through electoral defeat, a CGT is likely to be back on the table.

It’s impossible to gauge if or when that might happen. However, there is a precedent.

Impact On Property Investors

What Impact Would A Capital Gains Tax Have On Residential Property Investors?

Even if introduced, a capital gains tax is unlikely to impact long-term property investors significantly.

That’s because many Kiwis use the equity within their own homes to grow a property portfolio. There are few other passive investments they can use this equity for.

So, taxing any gains won’t necessarily see that wealth pumped into alternative asset classes.

Any potential capital gains tax or extension of the Bright Line Test would likely cause investors to hold on to their assets for longer, leading to a less dynamic housing market.

A slow-to-respond property market would potentially push prices up. That’s because investors are less likely to put their properties on the market, even if prices are rising.

This could lead to short-term supply shortages, which exacerbates rising prices further.

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?

10 years. The extension was introduced in March 2021.

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

Question: Does New Zealand have a Capital Gains Tax?

No, New Zealand doesn’t technically have a Capital Gains Tax.

However, there is the Bright-Line property rule, and it’s New Zealand’s lite-version of a Capital Gains Tax.

The Bright-Line Test NZ states if you sell a residential property you have owned in New Zealand for less than 10 years you may have to pay income tax on the gain.

Will We See A Capital Gains Tax Introduced In New Zealand?

A Capital Gains Tax is unlikely to be introduced within the short term.

Prime Minister, Jacinda Ardern, has stated that after trying to introduce a capital gains tax for 9 years, she has had to accept that New Zealanders are not supportive of the tax.

Related Articles

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.

1601614029185

Ed McKnight

Ed McKnight is the host of the Property Academy Podcast – NZ's #1 business podcast. He is an economist, having studied at the University of Auckland and the University of Waikato. He's a frequent writer for Informed Investor Magazine and has contributed to NewsHub, Stuff, OneRoof and Property Investor Magazine.