Is the Sale of Your Property Subject to Tax?
New Zealanders love property. Buying and selling property in New Zealand is common. What is less commonly known are the tax implications of these transactions. For many years, people have used property as a way to increase their wealth. It has been an almost rite of passage for every kiwi to buy a “doer-upper” and sell it to provide money for their future or next property purchase. However, New Zealand has a body of tax law which is aimed at ensuring property transactions are subject to income tax in some circumstances. This article considers some of the income tax implications relating to property.
Property Compliance Team
Inland Revenue have an active Property Compliance Team that focus on the enforcement of tax in relation to land transactions. This includes both income tax and GST. With IRD numbers being provided for every property transaction in New Zealand, Inland Revenue have access to real time information. Inland Revenue’s Property Compliance Team analyses the information relating to property transactions to ensure tax compliance. Inland Revenue also has very wide powers which enables them to gather information from third parties. They will often obtain a copy of the bank’s lending documents and bank statements as part of the investigations. It is common that Inland Revenue might obtain bank documents prior to you even knowing you are being investigated.
It is important to note that the burden of proof rests with the taxpayer for civil tax matters. This means the taxpayer needs to prove, on the balance of probabilities, that they have complied with their tax obligations correctly. Disagreeing with Inland Revenue or even proving Inland Revenue are wrong is not enough. It is necessary for the taxpayer to prove that they are correct.
Intention or Purpose
If you are purchasing a property, your intentions at the time of purchase are relevant to the tax treatment upon disposal. If you have an intention or purpose of disposing of the property, then the profits are usually taxable income. This does not need to be the main intention or purpose. Another thing to catch people out is that disposing of the land doesn’t just mean selling, it also covers situations like gifting or settling on a trust.
This taxing provision considers the intention or purpose at the time the property was acquired and it is irrelevant if that intention or purpose did not eventuate. Any profits arising from the disposal of land that was purchased with an intention or purpose of sale will then be taxable upon the disposal of the land. When deciding if there has been intention or purpose, Inland Revenue has the benefit of hindsight. For example, if the property has been purchased and sold within a reasonably short period of time, then this may lead them to investigate whether or not the property was purchased with an intention or purpose of sale.
This is when Inland Revenue will often use their information gathering powers to obtain information from third parties such as a copy of the bank’s lending documents. Bank documents often contain information relating to the taxpayer’s intentions or purpose of the property purchase.
Dividing or Developing Land
Profits received from disposing of land will be taxable in some cases where an undertaking or scheme is carried on to divide or develop land. When the property is acquired and disposed of within 10 years, such development or division will be subject to tax when the work undertaken is more than ‘minor’. Factors like time, effort and costs involved will be considered. In practise, most cases of developing or dividing land within 10 years of acquisition will be subject to tax.
When the land is owned for ten or more years, a development or division will be subject to tax where there has been significant expenditure on channelling, drainage, earthworks, kerbing, levelling, roading or any other amenity, service or work customarily undertaken or provided in major projects involving the development of land for commercial, industrial or residential purposes. Inland Revenue has applied this to tax small developments of only a few sections where the costs involved in the works were high.
When considering whether these taxing provision will apply, Inland Revenue will consider if the work was non-developmental, and any future expenditure that has not yet been incurred on the undertaking or scheme. They will also consider factors like the value of a person’s time, effort, or use of machinery or other equipment in undertaking the development work, and the context of the project.
A special taxing provision applies to tax property disposed of within 10 years where the property has been subject to a change in the conditions of the Resource Management Act (such as rezoning, or removal of obligations/restrictions) and at least 20% of the gain on disposal is attributable to that change. In this case, a valuer should be engaged to advise whether any gain is attributable to rezoning. If this section applies, then there is a 10% discount for each full year of ownership. This section can only be applied if one of the other land taxing provisions does not apply.
Builders, Dealers and Developers of Land
If you are a builder, dealer or developer of land for tax purposes, then you will be subject to tax on any property disposed of that is part of that building, dealing or development activity. This is reasonably straight forward as it is the profits of those businesses. However, any property that is not part of the business activity will also be “tainted” and subject to tax upon sale if it is disposed of within 10 years. For example, a dealer of land might own a rental property which is not part of that dealing activity. If that rental property is sold within 10 years of acquisition, then it will be subject to tax when it is sold.
Strict “associated parties” rules were introduced to ensure that builders, dealers and developers of land were not able to use their associates to profit from their activities without them paying the required tax. There are strict rules about who is considered to be an associated party. For example, the partner of a developer and a company where the developer is a shareholder will be subject to the same tax rules as the developer. This stops people “structuring” their way out of the tax rules.
Association with any dealer developer, or builder at the time you purchase a property, or undertake improvements to that property, can lead to that property being subject to tax upon sale.
Another key point is that when one party sells property to an associated party, the party that purchases the property will be subject to the same tax treatment as the vendor. This often catches people who want to restructure. For example, a company purchases a property with the intention to divide it into two and then erect two houses and sell them will hold that property on revenue account and will be subject to tax upon sale. If the company then decides to rent the property rather than sell it, it might consider transferring it to an associated company. The associated company will still hold those properties on revenue account and will be subject to tax upon the ultimate sale. The new owner’s intentions, purpose, or use of the property do not affect this. While there may not be a gain between the initial purchase and the transfer and, therefore, little tax to pay, the fact that the new owner will then hold that property on revenue account can cause problems in years to come when the property is ultimately sold.
There are several exclusions to the above rules, the main ones being the residential land exclusion and the business premises exclusions. It is important to note that in some circumstances, the family home will not benefit from the exemption where it is owned in either a company or even a family trust.
When none of the above land tax provisions apply, Inland Revenue can still apply the bright-line test which is a capital gains tax for land disposed of within a certain period of time. This is essentially a capital gains tax in disguise. Previously, the bright-line test applied to tax all properties disposed of within five years of acquisition. New Rules announced the extension of that test from five to 10 years. See this article for more information on the changes to the bright-line test. The bright-line test provides that any property sold within 10 years of acquisition will be taxable upon sale regardless of the intent when purchased. The bright-line test for properties acquired before 27 March 2021 is five years, not ten. The old, five year rule is also applied if the offer was made on or before 23 March 2021 and the offer could not be revoked before 27 March 2021.
There are some exclusions to the bright-line test such as a transfer pursuant to the relationship property agreement or an inheritance. The main exclusion is known as the main home exemption and this exclusion is not as simple as some might think There are issues when the property is owned by the trust, it does not apply at all when the property is owned by a company, and there are rules about when it will apply to individuals.
The main home exclusion was also changed when the bright-line test was extended to 10 years. Under the previous rules (and the rules that still apply to those properties grand-parented under the five year bright-line test) a property was either treated as a main home with a full exemption to the bright-line tax, or it would not be a main home. The exclusion applies as long as the property was used as the owner’s main home for more than 50 percent of the bright-line period. The new main home exemption that applies to those properties captured under the 10 year bright-line test means that the exemption will no longer apply on an all or nothing basis, but instead will apply for the period the property is used as the owner’s main home. See this article for more information on the main home exemption.
Land tax is complex but important to get right. If you have any concerns in relation to your own tax position, get in contact with Julia Johnston for specialist tax advice.