Earlier this year, the Government announced a housing package that sought to address the undersupply of housing across New Zealand. One of the principal tax policy measures was the extension to the residential bright-line test which came into force on 27 March 2021. Settlors and trustees of trusts holding property and land need to understand what this means to avoid unintended tax consequences for trusts.
What is the bright-line test?
The bright-line property rule imposes a tax on those who sell or dispose of residential property within a certain period of time unless an exemption applies. Tax is payable on any profit made from the sale.
If a property was purchased between 29 March 2018 and 26 March 2021, then tax may be payable if it is sold within a five year period. If a property was purchased after 27 March 2021, then tax may be payable if it is sold within a ten year period.
Family homes are generally not subject to these rules provided that they are the main home of the seller. This is known as the main home exemption.
How does the bright-line extension impact family homes held in trusts?
If trustees sell a family home, the main home exemption may be available. Trusts can benefit from the main home exemption provided that a beneficiary lives in the home as their main home and the settlor of the trust either lives in the property as their main home or does not have a main home. Tax may be payable if the property was not a main home for any part of the period that it was owned.
Can a trust use the main home exemption for future property sales?
The main home exemption cannot be used if the trustees have used the exemption twice or more in the two years prior to the date of any current sale of a home or engage in a regular pattern of buying and selling residential land. Tax can apply if there are resettlements and distributions of assets from trusts and so care needs to be taken not only when selling homes but also when trustees resettle or distribute them to beneficiaries. If trustees sell a home, also sell the replacement home and then resettle or distribute a third home in quick succession, they may lose the benefit of the exemption.
How does the bright-line extension impact residential investment properties held in trust?
This depends on when the investment property was acquired. If the investment property was acquired between 29 March 2018 and 26 March 2021, the property will be subject to the five year bright-line period. If the investment property was acquired on or after 27 March 2021 and is not a new build then the property will be subject to the ten year bright-line period. If the property is a new build then the five year bright-line period will apply.
This means that all residential investment properties (that are not newly built) acquired after 27 March 2021 and sold or disposed of within ten years will be subject to tax.
I want to transfer an investment property into trust – will that transfer be impacted by the bright-line test?
Potentially. Depending on when you purchased that property, you may be caught by the rules. Even though you may not sell the property to the trust, the transfer will be a deemed disposal for tax purposes and if you are within a bright-line period, tax will be payable.
The transfer date will also become the start of a new bright-line period. If the trustees decide to sell the property within the following ten years, tax may be payable on that sale. It will be important to consider the intended long-term plans for the property before any transfers are made. In many instances, the benefit of protecting a property from relationship, creditor or business claims is greater than the tax consequences of the bright-line test and a trust is still the best way to manage and protect that asset.
What do trustees need to do?
Trustees must take care and seek proper financial and legal advice before acquiring and disposing of residential property. If you require assistance with structuring the transfer of assets to and from trusts, contact Morris.