The Bright-line Test – Understanding It Through a Real-World Example
Selling your property is often a lifestyle driven decision, that carries massive financial implications. The Bright-line Property Rule is an essential consideration in this process so it pays to understand the key dates before you go much further with your plans. In this article, I explore this rule by examining a real-world example: Selling a home for $1.3m that was purchased 2 years ago for $1 million and rented out for 50% of the time.
What is the Bright-line Property Rule?
The Bright-line Property Rule (or Bright-line Test) determines whether you’ll pay income tax on any capital gain made from selling a residential property within a specific period. Even though it’s a gain made from rising prices, this is assumed to be ‘income’, so the rate of tax you pay will be the similar to if it was normal income. For New Zealand tax residents, this rule can also capture overseas residential properties.
The Bright-line Test Period
The criteria for the Bright-line Test period has changed several times:
- 1 October 2015 to 28 March 2018: 2-year threshold
- 29 March 2018 to 26 March 2021: 5-year threshold
- 27 March 2021 onwards: 10-year threshold, or 5 years for a qualifying new build
Consider a property bought for $1 million 2 years ago and sold for $1.3 million today. Since the property was acquired after 27 March 2021, the 10-year threshold applies. Assuming it was purchased initially as an owner-occupied home, no longer matters if in fact it was rented out.
So considering the property was rented out for 50% of the time. This may lead to some apportionment of tax liability (as partial occupancy of the family home during the relevant test period is considered). Give the property was a home for almost 2 years but for half the time it was rented out, 50% of the capital gains would likely be taxed as personal income. If the home owner was in the highest tax bracket, 50% of $300k, or $150k would be taxed at 39%: a tax bill of $58,500.
In this case, seeking legal and/or tax advice is crucial.
Because the BLT rules have been changed so frequently, and the last change was significant, many recent home owners may not be aware that if the property was rented out for any period of time within 10 years, that could trigger a requirement to pay tax.
I should point out that there are some exemptions including distributions from estates, company changes, sale of farmland and certain situations involving trusts. Again, best to get legal and tax advice before you make decisions. The main thing is to not assume things are as simple as they used to be, and allow for the retention of cash from some of the net sale proceeds of the property to account for the tax, if it comes up.
The Bright-line Property Rule is a complex set of tax rules regulation with significant financial implications. A comprehensive capital gains tax would be far simpler to roll out, however this is politically unpopular and may have other downstream effects that could damage the overall well being of our economy. Our example of a $1 million home that sold for $1.3 million illustrates the importance of understanding this rule and seeking professional advice BEFORE engaging with a real estate agent.
If you’re a property investor who’s offloading surplus properties, there’s even more to unpack (that’s another blog) but until then, please do reach out if you have anything you require advice on. Whether you’re a homeowner, investor, or real estate professional, understanding the Bright-line Test is vital to making informed decisions.
If all this talk of tax has you thinking about our tax rules in NZ, then you may benefit from this conversation with Robin Oliver, specialist tax adviser recently.
For information direct from the IRD: https://www.ird.govt.nz/property/buying-and-selling-residential-property/the-brightline-property-rule