Can you be liable for income tax on the sale of your family home?
The Bright Line Test is not a new rule , it was introduced by the John Key led National party and took effect from 1 October 2015. The purpose of the test is to ensure that tax is paid on profits where properties are bought and sold within a short amount of time. Some of these transactions would have been taxable anyway under the various rules that already existed to tax property sales but most commentators seem to agree that tax was not being paid on much of the short term buying and selling that was going on prior to introducing the rule.
The Bright Line Test has been through several iterations. Initially the relevant period was two years, but the rule was updated effective 29 March 2018 and again on 27 March 2021 to 5 years and then 10 years.
From the point of view of gaining more tax from short term property transactions it seems likely that the tax has had its desired outcome. As time has gone on however we have noticed some perhaps unintended consequences including situations where people can end up paying tax on the sale of their own home.
Family home excluded – mostly
Mostly, the family home is excluded from the bright line test which is intended to capture second homes like rental properties or baches. In some situations though the family home can be captured.
When the time frame moved from 5 years to 10 years, the wording for the main home exclusion was changed. Initially, and while the bright line test was for 5 years, in order to claim the main home exclusion a person needed to have lived in the house more than 50% of the time that the property was owned. That changed when the 10 year test came in on 27 March 2021. Properties sold after this date have in effect a grace period where you can live away from your house for up to 12 months before you need to consider the bright line test.
Both of these rules can result in tax being payable in situations where you may not expect it. See examples below:
Property bought between 29 March 2018 to 27 March 2021
A house purchased during this period and sold within 5 years, will be liable for income tax on the gain on sale unless the main home exclusion is claimed.
If a section is purchased in this period and subsequently built on, it is the date of purchase of the section that is treated as the purchase date of the house.
As an example, a client purchased a “house and land package” on 20 August 2020. At first it was just the title for the section that was transferred to the client, the house was not completed until 15 June 2021. That is 299 days for the house to be constructed. Clearly, the client could not live on that property for those 299 days and so their “main home” was elsewhere.
On August 19 2021 the client approached us to check whether tax would have been payable on the sale – it turned out they did not like their new suburb.
For the main home exclusion to apply the house must have been lived in for most of the time i.e a period longer than the 299 days of construction. Because there was no house to live in until it was constructed, the client had not lived in the property for long enough to claim the main home exclusion.
Our client decided they were happier to stay in their property rather than pay a significant sum of tax just to move house. Although on paper they had made a gain in the value of the property, the value of the property that they wanted to move to had increased by broadly the same amount. On that measure, the impact of the tax would have been to leave them worse off financially than they were when they bought the new house to live in.
It seems unlikely that this situation was intended to be captured when the rules were being drafted as the person was not a property investor or house flipper, just a person who built a new house who, having lived in the property, did not like it as much as they had hoped.
Property bought 27 March 2021 onwards
Note that for property subject to the 10-year bright-line period, in a similar scenario there would be 12 months for the owner to complete the property before there would be at least some application of the bright line test. In these times of materials and labour shortages it’s easy to think of a scenario where someone’s new build or even renovation project extends beyond 12 months.
Of course there are many other reasons why people may be living in a different house for example a career stint overseas, family reasons or even a serious medical event requiring a temporary move to a specific hospital to be close to treatment. Again, it seems unlikely that it was a policy intention to subject people moving around for these reasons to income tax.
Other rules/exemptions/sticking points?
The application of the bright line test can be complicated and all property transactions involve significant amounts of money. This article is not intended to be a summary of the rules that apply, just an example of one potentially unexpected tax outcome. It is important to seek advice before making any property transaction (including restructuring ownership).
Please get in touch with us if you have any questions regarding the bright line test.