Update June 2024: Note that from 1 July 2024, the bright line test reverts back to two years. More about this update here.
From time to time we get asked by clients about moving their rental property into a different entity. Usually when doing this, a property will be “sold” to a related party.
The reasons for the request vary but usually relate to a change in the relationship of the people that own the property, a perceived tax benefit from restructuring the finance at the same time as the ownership or else a new desire for asset protection.
As property transactions tend to involve big numbers it pays to consider the broader picture before making any change.
General Anti Avoidance Rule
One rule which may cause issues here is the General Anti Avoidance Rule (GAAR for those who like acronyms!) contained within our income tax act. Put simply, this allows the IRD to void any transaction where there was a more than incidental purpose of saving tax. This is a risk to be considered for people wanting to move some of their lending from their home mortgage to their rental property.
Depreciation recovery
There has been no depreciation allowed on buildings in NZ since the 2012 financial year. Despite this, many people with investment properties have held the property for longer than this so have claimed some depreciation on the building in the past. Other people have claimed depreciation on parts of their rental property, for example, the carpets, or the dishwasher.
With prices having risen significantly across most of New Zealand over the last few years, much of this depreciation will need to be added back to income if the property is restructured into another entity. This may bring forward significant tax liabilities in some cases.
Bright Line Test
Even if neither of the first two issues apply in a particular situation, it is always important to consider the “bright line test”. Brought in by the National government in 2015, the bright line test had the effect of making the profits on the sale of any land (except for your own house) taxable if the property was sold within 2 years.
The new Labour led government then extended this timeframe, first to 5 years (effective 29 March 2018) and then to ten years (effective 27 March 2021). Also there is “rollover relief” which at the time of writing in November 2022 the process of being expanded which will assist in some specific situations where there is a change in the legal structure but the people involved are the same (for example, some transfers to and from trusts).
Get advice
As always, everyone’s situation is different, and this commentary is general in nature. It would pay to get specific advice for your situation. Feel free to contact us to discuss further.