Bright-line test: Don’t get caught by ‘change-of-use’ rule fishhook
Anyone who lives away from their main home for more than a year will be liable to pay income tax on any profit they make from the sale of a residential property sold within the new bright-line period.
That’s because of the introduction of a ‘change-of-use’ rule that came into effect when the Government amended the legislation earlier this year, in its bid to cool rampant property prices in New Zealand.
For salary and wage earners who are renovating their house, away on secondment or looking to build a property, a hefty and unpleasant tax bill may be lying in wait as a result of this fishhook.
Detailed explanation
Under the bright-line test, an exemption applies if the property a person is selling is their main home.
Prior to 27 March 2021, a property was considered a main home if the owner had lived in it or used it as a main home for at least 50 percent of the time that they owned it.
However, under the new bright-line rules – which apply to a residential property that someone purchases on or after 27 March 2021 and sells within 10 years – homeowners can only be away from their main home for a continuous period of up to 365 days.
Homeowners must treat the days they are away from their main home as ‘non-main home days’.
If someone is away for more than 12 months and then later sells their house within 10 years of acquiring it, the main home exemption will not apply.
This is the 'change-of-use' rule.
It means a person will have to pay income tax on the profit they make from that sale for the period they were not using the property as their main home.
Example
A homeowner sells a property six years after the start of the 10-year bright-line period.
During that six-year bright-line period, they had moved out and rented this house for 15 months while they lived and worked in another part of New Zealand.
Any profit will be split between the 15 months and remaining 57 months during the bright-line period. The homeowner is liable to pay tax on the amount of profit apportioned to the 15-month period.
The impact for salary and wage earners
This has potential – and unpleasant – tax ramifications for salary and wage earners who:
- Renovate their home.
- Live away from their main home due to being on secondment.
- Purchase a section with the intention of building a property, especially if it is going to take more than a year after buying the section to move into their newly built house.
The income a salary and wage earner receives from selling a property is added to their other income sources for that year.
For most, given the eye-watering sums some houses are currently fetching on the market, this will force them into the top tax bracket of 39 percent for that year. The top tax bracket applies to those earning income above $180,000.
There are potential provisional tax ramifications, too.
If the income tax liability from the sale of a property is $60,000 or more, a salary and wage earner will need to pay this by 7 May to avoid incurring IRD interest (currently seven percent) – even if there was no obligation for this person to pay provisional tax during the income year they sell the property.
This is because they fall outside the safe harbour provision.
They can, however, use an IRD-approved tax pooling provider such as Tax Management NZ to reduce this interest cost by a notable amount. The savings can be significant.
They will also enter the provisional tax regime during the following income year due to the previous year's income tax liability being greater than $5000.
Anyone who expects to be away from their home for more than 12 months will need to keep accurate records of the number of days they live away from the property as well as any deductible expenses they wish to claim against the property's sale proceeds.
Seek advice
The rules around the taxation of property are complex.
As always, we recommend you speak to an accountant if you have any questions or wish to err on the side of caution.
Seller beware – IRD bright-line campaign update
Inland Revenue (IRD) will soon begin issuing letters to taxpayers within a month of them selling a residential property.
These will be sent as soon as the tax department identifies a transaction that potentially falls within the bright-line rules, to ensure people are aware of any possible tax obligations.
IRD says initially there will be a couple of catch-up rounds to account for residential property sales from November to June 2021.
From there, they will issue letters monthly as sales occur.
What to do if you receive a letter
In some circumstances, IRD may not be applying the law correctly because they don’t have all relevant facts.
Last year, the department acknowledged it sent letters by mistake to taxpayers whose property transactions did not fall under the bright-line test.
Still, it pays to speak to a tax professional if you are unsure or have any questions because the taxation of property is quite complex.
If you have sold a house and not returned the correct taxes, then you should complete a voluntary disclosure as soon as possible.
This can see the shortfall penalties IRD may seek to impose on the unpaid tax reduced. Shortfall penalties range from 20 percent up to 150 percent of the tax liability, depending on the seriousness of the mistake.
As an IRD-approved tax pooling provider, Tax Management NZ can eliminate late payment penalties and reduce the interest that the taxman may already be charging on the income tax amount owing as a result of a property sale, provided legislative requirements are met.
Please contact us to find out how and when we can assist with tax obligations that arise when a property sale meets the bright-line criteria.
The bright-line rules
The bright-line test means if you sell a residential property within a set period after purchasing it you will have to pay income tax on any profit made through the property increasing in value, unless there is an exemption.
It also applies to New Zealand tax residents who buy overseas residential properties.
Please refer to the table below to see which bright-line period applies.
| If the property was purchased… | Then the bright-line sale period that applies is… |
| On or after 27 March 2021 | 10 years |
| Between 29 March 2018 and 26 March 2021 | Five years |
| Between 1 October 2015 and 28 March 2018 | Two years |
The bright-line test does not apply to houses purchased before 1 October 2015.
Please note the Government has also indicated new builds acquired on or after 27 March 2021 will continue to be subject to the five-year test.
Exemptions
Generally, the bright-line property rule does not apply to a sale of property that has been your main home, inherited property, or if you're the executor or administrator of a deceased estate.
It's important to keep in mind that the main home exemption is not infinite, and can only be used twice in a two-year period.
However, different rules apply to someone's main home depending on when it was acquired.
Prior to 27 March 2021, a property was considered a main home if the owner had lived in it or used it as a main home for at least 50 percent of the time that they owned it.
Recently, though, the Government has introduced a ‘change-of-use’ rule.
This states that, after a sale, income tax will be payable for any period of more than 12 months if the property was not being used as someone's main home.
Visit IRD’s website for more information on the bright-line test and other property rules.