Everything you wanted to know about the bright line test you wanted to know but were afraid to ask

Because property is in the news (like it always is) and because fantasy property taxes are also in the news (like they always are). I thought it might be helpful to give you a run down on the "bright-line test" that applies to residential property. It is often talked about in the media but rarely with a lot of clarity. 

Sometimes journalists call it a type of capital gains tax, sometimes they say it is "like" a capital gains tax. I can see why they do this but it's not really all that accurate. To be fair, political journalists should not necessary be expected to know a lot of about property and tax which are, of course, specialist disciplines.

I'm not a tax expert either. And none of this is specific advice (or even general advice). But as a general guide, this may be of some assistance in understanding what people are talking about.

Is there such a thing as a bright-line tax?

No. There is no such thing as a bright-line tax. The bright-line test is a test that tells you whether income tax is payable in respect of a particular transaction. The tax payable is income tax and is assessed at the taxpayer's marginal income tax rate (as with PAYE).

Why did they bring the test in?

You might not pick this up from columns and news article, but it has always been the case that anyone who buys a property with the intention of re-selling it for gain is subject to income tax on the gains. This is known as the "intention" test. Gains that do not arise from an intention to re-sell but as a kind of happy accident of ownership are not taxable.

The intention test is hard to enforce because of the difficulty of proving what the owner's subjective intention was at the time of the transaction. That's not to say it was never enforced (see here, for example). But it wasn't exactly rare for it to be flouted either.

The bright-line test is therefore an enforcement mechanism that creates a strict assumption that anybody buying or selling an investment property within a specified time did so with the intention of making a profit on it (and so should pay tax).

Put it this way: the bright-line test simply takes away your right to argue you weren't seeking a profit within the bright line period. You are assumed to have earned income (which is taxable) and not merely enjoyed capital gains (which are in theory not taxed).

What is the bright-line period?

Currently the period is five years. When initially brought in by the previous National government, the period was two years. Grant Robertson seems to be considering a lengthening of the period.

Is it payable on every house sold in the bright-line period?

No. Taxpayers have a limited right to claim an exemption on the basis of the property being their main home. There are also exemptions that cover things like relationship property claims, wills and estates and so on.

How do they enforce the test?

Lawyers and conveyancers must, when submitting any transfer of property, communicate the tax details of their client to Land Information New Zealand who pass that information onto the IRD.

Is it a capital gains tax?

Not in form, no. It might look like that in some ways but the underlying thrust of the system is still about capturing people who are engaging in speculation. What it amounts to is not allowing somebody to claim they weren't speculating when they buy and sell a property within a certain, short space of time.

Where does this fit in to the tax proposed by the tax working group?

The National government having put in place the basic architecture, Labour's Tax Working Group suggested that a de facto capital gains tax be created by simply removing all time limits under the bright-line test. In effect, there would be no test any longer because every transaction would create a tax liability if gains were realised and no exemption applied. The tax would also have extended to other assets like shares an investments in managed funds (like Kiwisaver accounts). 

This probably would be a capital gains tax because, if implemented, the regime would obliterate the intention test altogether rather than just in certain circumstances.

Are there other tests for taxing land sales?

Yes. certain other land transactions are liable for income tax unless an exclusion applies. For example, property developers and people undertaking subdivisions requiring more than minor work have their own ten-year "bright-line" test. There are plenty of others.

Is it easy to get around income tax?

Not really. The test is strict and captures a number of situations which people might not really think to be very fair. For example, Inland Revenue once applied the bright-line test when a Waiheke Island property by somebody in her own name was transferred to a trust for a purchase price of $2,850,000. A year later it was sold to a third party for $5,200,000. Under the bright line test, this created a tax liability of $775.000.00. 



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By becoming a patron, you'll instantly unlock access to 68 exclusive posts
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13
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