Bright-Line Test & Trust
What is bright-line test?
The bright-line test is a clearly defined rule that determines whether tax should be paid on capital gains from sale of residential property (with some exemptions). The bright-line test rules have applied to residential land sales since 1 October 2015 and initially imposed a tax on profit on any residential property bought and sold within a two-year period. However, in 2018 this rule was extended to five years, effective from 29 March 2018.
When does it apply?
The bright-line test applies to profits on the sale of residential property where:
- The property was acquired between 1 October 2015 and 28 March 2018 and sold within two years of acquisition; or
- The property was acquired on or after 29 March 2018 and sold within five years of acquisition.
What are the exemptions to the rules
The bright-line test does not apply to business premises or farmland.
It also does not apply if the residential property being sold is the main home, part of an estate distribution, relationship property or Maori Land.
Is a trust property exempt from the rules?
If a trust owns the property being sold, the main home exemption will apply when it’s the main home of a beneficiary of the trust.
Issues with the bright-line test and trust – when does the bright-line test trigger?
It is important to understand when and how the bright-line test is triggered in regards to a trust. Trustees of the trust must take care and seek proper financial and legal advice before acquiring or disposing residential property.
The most common pitfalls to look out for are noted below:
Nominations are common where parties commit to buying a property and then opt to nominate the trustees of their family trust to complete the purchase of the property. Timing of the nomination is -2
crucial as Inland Revenue has clearly stated that nomination means acquisition of property. There are two potential issues to watch out for when nominating your trust:
- Relevant date of the value – signing the contract and the subsequent nomination is an “acquisition and disposal” for the purposes of the bright-line test. Therefore, Trustees of the trust must compare the value of the property from the date of signing the agreement and to the date of nomination. For example, if the nomination takes place weeks after the parties entered into a contract to purchase, the value of the property is most likely not changed. However, if the nomination occurs months or years after signing the initial contract and the value of the property is increased, then this increase is taxable under the bright-line test.
- Relevant date of the on-sale– Trustees should be aware that if relying on the five year rule to sign a contract to sell residential property (which is not the main home of a beneficiary), the relevant date of acquisition five years prior will be the date they signed the Deed of Nomination and not the date the contract was entered into pre-nomination.
- Transfer of personal property to trust
Any residential property transferred to the Trustees of the trust is a transfer that re-triggers the bright-line rules. It is important for you to think about the future intentions to a property before transferring it. If yourself or Trustees of the trust intend on selling the property in the next five years, then that should be factored before the transfer. For example, if you have personally owned a beach house for 15 years and then decide to settle that property, onto a trust, the date of that transfer to the trustee will become the acquisition date for the purposes of the bright-line rules and any subsequent sale of that property will be taxable.
- Resettlement of Trust
Resettlement occurs when all or some of the property of a trust is resettled into a different trust. When property is resettled into another trust, no consideration is paid by the recipient Trustee(s). However, for tax purposes, the property transferred is valued at market value. The same value is used by both the resettling and the recipient Trustee(s). Such transfer by resettlement will trigger the bright-line rules and tax will be payable.
In conclusion, it is our recommendation that before acquiring or disposing any property, you seek proper financial and legal advice.