The Government recently increased the brightline period from 5 years to 10 years, with it applying to residential land acquired on or after 27 March 2021. The Government’s media statement announcing this change stated the change will remove incentives for speculators and help dampen demand.
Inland Revenue’s view is that land is acquired when there is a binding agreement in place between the parties. Therefore, a purchase of land that settles on or after 27 March 2021 is still subject to the 5 year brightline rule as long as a binding agreement had been entered into by the parties prior to 27 March 2021.
The result of this change is taxpayers will be subject to tax on a gain from disposing of residential land, which is not the main home if it is acquired and disposed of within the 10 year brightline period.
The Government also announced that the 10 year brightline period would not apply to a “new build”. As yet no legislation has been prepared to bring this rule into effect or to define what a “new build” is. The Government has advised it will consult on the definition of “new builds” before introducing legislation. It has been indicated that this legislation will be made retrospective to “new builds” acquired on or after 27 March 2021. It is likely the devil will be in the detail of this legislation.
The brightline test was introduced from 1 October 2015 by the National Government with a 2 year brightline period to supplement the “intention test” in the current land sales rules. Under the “intention test” a gain made on the sale of land is subject to tax if it was acquired with an intention or purpose of resale. However, due to the subjectivity of the intention test, not all taxpayers were complying with the rule and it was hard for Inland Revenue to enforce. The brightline test created an easy-to-enforce, objective test, which essentially treated anyone acquiring and disposing of residential land within a 2 year period as a “speculator”.
The Labour Government increased the brightline period from 2 years to 5 years for land acquired on or after 28 March 2018. The media statement at the time announcing this change stated the change “will help dampen property speculation and make homes more affordable”.
When the Labour Government has extended the brightline period, it is clear from its media statements that the original intent behind the brightline test has been widened so it can also be used as a tool to dampen the property market. We are concerned the Government is using the brightline rule as a way to dampen the housing market as this does not directly deal with the housing shortage that is causing house prices to spike.
One of the Labour Government’s reasons for extending the brightline period from 2 to 5 years in 2018 was to make homes more affordable. Arguably, this has not worked as we are in the midst of a property boom, therefore there is a big risk that “tinkering” with the brightline period again will have very little effect but have other unintended consequences.
An issue with the 10 year brightline period is the gain that is taxed does not take into account any general inflation over the brightline period, therefore, taxpayers end up being taxed on general inflationary gains. Arguably, this issue was not as significant when the brightline period was 5 years. We believe that the Government needs to give consideration to adjusting the taxable gain for inflationary gains, however, this adds further complexity into the tax system, which is unnecessary.
From the 2022 tax year the top marginal tax rate for individuals has increased to 39% for income over $180,000. Increasing the brightline period is likely to see many taxpayers have a significant portion of any gain under the brightline test being taxed at 39%.
For example, a husband and wife earning a gross salary of $80,000 each per annum acquire a residential rental property and sell it 9 years later. The median increase in house prices for the 12 months ending 31 December 2020 was $117,000. Assuming this continued, the husband and wife would have a gain of $1,053,000 after 9 years that they would be subject to tax on along with their salary and wages. They would each be taxed on half of the gain, being $526,500, resulting in $853,000, or 81%, of the total gain being subject to tax at 39%.
We believe this is not a fair outcome when in a “normal” year the income of the husband and wife is well below the 39% tax threshold. To overcome this, consideration should be given to allowing taxpayers to spread the gain back over the tax years the gain accrued over but, once again, this adds further complexity to the tax system. It should be noted that there are already provisions within the Income Tax Act that allows certain income to be spread back and taxed in prior tax years.
The husband and wife could “get around” the 39% tax rate on the gain by owning the property in a family trust and having the gain taxed at a flat rate of 33%, a tax saving of 6%. The result of this is that tax outcomes are driving business decisions, which results in tax inefficiency and increased compliance costs.
It is much more important now that residential rental property investors choose the correct ownership structure at the time of acquiring the property. If an investor wants to transfer the property to a new structure then it will trigger the brightline test if sold within 10 years. However, if the investor waits until after the 10 year period so as to not trigger the brightline test, it will result in the 10 year brightline period starting again for the acquiring entity.
It will be very interesting to see whether extending the brightline period to 10 years will have the intended effect of cooling the housing market.
Armed with an extensive knowledge bank, Brad specialises in providing taxation services to clients in the corporate, business, and rural sectors. He also has a keen interest in valuation, asset protection, and estate planning matters.