The Bright-Line Test and Main Home Exemption – What You Need To Know
On 23 March, the Government passed their amendments to the residential-property bright-line test under urgency, and without consultation via a Supplementary Order Paper (SOP).
Under the previous bright-line test, anyone who disposes of a residential property within five years of acquisition is liable to be taxed on the capital gain, unless it is an exempt property. An exempt property is one that is subject to the main home exemption, is an inherited property, or is subject to a relationship property settlement.
The new bright-line test extends the bright-line period to 10 years for any existing property acquired on or after 27 March 2021. If an offer was made by the purchaser on or before 23 March 2021, provided the offer could not be revoked before 27 March 2021, then it will fall under the five year bright-line test. The bright-line tests for new builds will also fall under the five year bright-line test.
There will be consultation around what will qualify as a 'new build', and retrospective legislation is intended to be introduced. A new build is intended to include properties acquired within a year of receiving their code compliance certificate under the Building Act 2004.
The main home exemption has also changed. 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.
The new legislation provides a 12-month change-of-use “buffer” so that a change-of-use to or from the property being the taxpayer’s main home does not need to be accounted for, but only if the property is not the main home for less than 12-months at a time. This is intended to provide leeway for moving in or out of a property. If the property is not the main home for more than 12 months, then income is attributable to the days that the property was not their main home. This is seen in the following example from the commentary to the SOP:
“Gerald purchased his home in January 2022. He did not move in until six months later as he was overseas. He sold the property in 2026.
The 12-month buffer applies as the period Gerald was overseas and not using the property as his main home was less than 12 months, and it was immediately followed by a period where Gerald used the property as his main home. Therefore, the main home exclusion applies despite Gerald not actually using the property as his main home for a 6-month period.”
The amendment means that the main home exemption will only apply for the period(s) that the property is used as the taxpayer’s main home. However, there is still a requirement that the property has been used predominantly as the taxpayer’s main home on a floor area basis. If the property is the taxpayer’s main home for the full bright-line period, then that property is not subject to income tax on disposal under the bright-line test. This is seen in the following example provided in the commentary to the SOP:
“Erica purchased a property in 2022. She lived in it with a flatmate until she sold it in 2027.
Under both the current law and the proposed change, the main home exclusion would apply. This is because for all of the bright-line period the property was used predominantly as Erica’s main home. The “predominantly” test looks at whether, on a floor area basis, the property was used at least 50 percent as the person’s main home.”
The deductions that a taxpayer can claim on the cost of the property (including acquisition cost and capital improvements) have been reduced and taxpayers can only claim the deductions for the period that the property was not the main home.
If the property is never used as the main home, the income is simply the amount they derive from disposing of the property.
If the property is used as the person’s main home for some of the time it was owned, the income is calculated by:
income from disposal – excluded adjustment amount.
The adjustment amount is calculated by: (adjustment days/total days) x unadjusted amount.
Adjustment days are the total number of days during the bright-line period where the property was used as a main home. It includes days that are counted as main home days because the 12-month buffer applies. Total days is the total number of days in the bright-line period that the person held the property. The unadjusted amount is the amount of income the person derived from disposing of the property. The following example from the commentary to the SOP shows how apportionment following a change of use will work:
Lexi purchased a property for $500,000 and it was transferred to her on 3 February 2022. Lexi sold the property on 1 November 2030 for $825,000. Lexi lived at the property as her main home from 3 February 2022 until 12 September 2026. Lexi then rented the property until 1 November 2030. Lexi’s income is calculated as follows:
Excluded adjustment amount = (Adjustment days)/(total days) x cost
= (1683/3194) x $825,000 = $434,713.53
= $825,000 - $434,713.53 = $390,286.47
Therefore $390,286.47 is Lexi’s gross income from the sale. A portion of the acquisition cost needs to be deducted to determine the net amount of income from the sale that is subject to tax
A person can claim a deduction for the cost of property subject to the bright-line test. Where there are excluded days from the bright-line period due to the property being a main home, the deduction that can be claimed is reduced. This is calculated by the following formula:
Excluded adjustment amount = (adjustment days)/(total days) x cost
The meaning of adjustment and total days does not change from the calculations above. Cost refers to the cost of the residential land. The following shows how to calculate the excluded adjustment amount:
Continuing with Lexi’s example, Lexi purchased the property for $500,000. It was transferred to her on 3 February 2022. The total period of ownership for Lexi is 3,194 days and the amount of adjustment days is 1,683.
Using the formula provided by the legislation, Lexi’s excluded adjustment amount is:
(1683/3194) x $500,000 = $263,462.74
Lexi’s deduction for the cost of revenue account property will be:
$500,000 - $263,462.74 = $236,539.26
The calculations combined show how the net income from the sale to be taxed is calculated:
Lexi’s income under bright-line is $390,286.47 and her deduction for the cost of revenue account property is $236,539.26.
Her net income from the sale is therefore: $390,286.47 - $236,539.26 = $153,747.21
Lexi would therefore pay tax at her marginal rate on $153,747.21.
Application to AirBnB and other Short-Stay Accommodation
Just as you might be thinking you will turn your rental property into short-stay accommodation such as an AirBnB to limit the application of the rules, the Government has taken steps to ensure that the bright-line test will apply.
The legislation has amended the “business premises exclusion” in the definition of “residential land” to ensure that residential property used to provide short-stay accommodation is subject to the bright-line test where the accommodation is provided in a dwelling that is not the owner’s main home. This includes a property that is rented out as part of the sharing economy on digital platforms, or a bach that is sometimes rented out when the owner does not use it.
Note that this amendment does not include a bed and breakfast type facility where it is also the owner’s main home and they rent out rooms for short-stay accommodation.
Like in the tests above, this amendment applies to property acquired on or after 27 March 2021. It does not apply to property acquired on or after 27 March 2021 as a result of an offer made by the purchaser on or before 23 March 2021, provided that offer could not be revoked before 27 March 2021. The existing business premises exclusion will continue to apply for such properties, as well as properties acquired before 27 March 2021.
The amendment will also ensure short-stay accommodation is subject to the residential rental deduction ring-fencing rules. This applies from the 2021–22 income year onwards, regardless of when the property was acquired.
The above is intended for informational purposes only and should not replace specific tax advice. For personalised advice on all tax issues please contact Julia Johnston at Saunders & Co.