The Brightline test and selling residential property
The Brightline test is also called the Brightline property rule and applies to residential property bought after 1 October 2015. Residential property includes a family home, residential rental properties, city apartments, serviced apartments, and bare land (sections). The Brightline test does not apply to retirement homes or commercial property.
Up to 28 March 2018 the Brightline test applied to property bought and sold within 2 years. On 28 March 2018 Inland Revenue extended the Brightline test to 5 years and then to 10 years on 27 March 2021. Therefore, the date the property was acquired will determine whether the Brightline period is 5 or 10 years. The 2-year period no longer applies.
The Brightline period generally starts on the date on which the instrument to transfer the land to the person was registered with Land Information New Zealand (LINZ), or under laws of a similar nature if the property is outside of New Zealand. In some circumstances, it may start on the date a person enters into an agreement to purchase the property before the title is registered.
The Brightline period ends on the date a person enters into an agreement to dispose of the property. This is usually the date of entry into the sale and purchase agreement, which will be the date of the agreement.
Is the Brightline property rule a capital gains tax?
Essentially, the Brightline property rule is a capital gains tax as it treats any financial gain made within the Brightline period as taxable income. This creates an income tax liability and the obligation to pay tax.
Exclusions to the Brightline test
Exclusions to the Brightline test include:
- the main home exemption
- inherited property
- residential property transferred to a person as an executor/ administrator of a deceased estate
There is also rollover relief for property transferred as a result of a relationship property agreement. This means that any potential income tax liability will be deferred until a later sale.
The Main Home Exemption – what you need to know
Generally, if the property has been the persons main home for the full Brightline period, then that property is not subject to income tax on disposal under the Brightline test and you will not have to pay tax. However, there are some fishhooks to this.
The main home exemption applies to the property a person lives in for more than 50% of the time. Secondly, more than 50% of the property must be used as their main home. This means if more than 50% of the property is a rental property or business premises, the main home exemption will not apply.
A person can only have one main home but if they have more than one home, the main home exemption applies to the home they have the greatest connection to, such as where their family live or where they spend more than 50% of their time. The test is based on a person’s actual use of the property and not the person’s intended use of the property.
The main home exemption may apply to the trustee of a trust if a beneficiary to the trust lives in the property. The main home exemption will not apply where only a family member and not the owner has used the property as their main home.
In very limited circumstances, a person may have more than one main home. For example, if the sale of the main home overlaps with the purchase of a new main home. The ownership overlap of the properties will not mean the original home fails to satisfy the requirements to be a main home for the previous period. If the two properties were sold at the same time, the owner could still use the main home exemption for both properties if they both satisfied the requirements to be a main home for the different periods.
Bare land can be problematic if a person purchases the bare land with the intention of building their main home but sells the bare land within the Brightline period without doing so. Having the intention to use bare land as the main home is not enough. A person must actually use it for this purpose.
The main home exemption can only be used twice over any 2-year period and does not apply if a person shows a regular pattern of buying and selling residential land.
Under the change of use rule, if the main home was not used as the main home for any continuous periods, or for more than 12 months during the Brightline period, the main home exclusion will not apply to those periods and income tax is apportioned to those periods.
What if the Brightline test does apply?
If the Brightline test does apply, you may need to pay tax on any financial gain, however you will be entitled to deductions for the property sale according to ordinary tax policy. This includes:
- The initial acquisition price of the property.
- Any expenditure related to the acquisition, e.g. costs to lawyers, valuers, surveyors and real estate agents.
- Incidental costs of disposing of the property.
- Any capital improvements to the property made after the acquisition, such as renovations.
The intention test
Prior to the introduction of the Brightline property rule, any capital gains made on the sale of residential property had always been treated as taxable income if one of the intentions when the property was purchased, was to resell it. On the other hand, if a residential property was purchased with the intention of keeping it as an investment property, such as a residential rental or business premises, then any capital gain made on the property sale was not taxable.
The intention test was extremely subjective and difficult to enforce. The objective nature of the Brightline test means that capital gains made on the sale of residential property that does not fall within one of the exemptions, is taxable income even when the seller did not acquire the property with an intention of resale.
How Crawford Nelson can help
The main thing is to be aware of the potential 5- or 10-year window that the Brightline test creates that may result in having to pay tax if not strictly observed. Inland Revenue is notified when residential property (including residential rental properties and city apartments) is sold within the Brightline property rule period and will make enquiries to the seller.
If you have concerns that you could be caught by the Brightline property rules, and liable to pay tax on the sale of your residential land, talk to Crawford Nelson. We are specialist tax lawyers and will ensure you understand the timing of the Brightline property rule in your specific circumstances.