Inner-city bolthole? Tenants funding your OE? Inland Revenue sets straight the main home exclusion to the bright-line test

Do you own, and use as a residence, two or more homes? Have you been absent from your main home during the bright-line period? If the answer is yes, you may have tax to pay if you sell your home within a bright-line period. Inland Revenue has released two pieces of draft guidance to assist homeowners facing these questions.

Consultation on both items runs until 30 May 2023:

• QWBA – If a person has two or more homes, which home is their main home for the purpose of the main home exclusion to the bright-line test?
• IS – Income tax – How absences affect the main home exclusion to the bright-line test

The bright-line test

The bright-line test taxes residential land sold within a certain period from the date of acquisition (‘the bright-line period’). The bright-line period is five years for land acquired from 29 March 2018 to 26 March 2021 and ten years for land acquired on or after 27 March 2021 (or five years for new build land acquired after 27 March 2021).

The main home exclusion

A person’s main home is not subject to tax if it is sold during the bright-line period (‘the main home exclusion’). Parliament made it clear that a person can have only one main home – and that this home must be used as a residence. What remained unclear, however, was how to determine which home is the main home if a person uses two or more homes as a residence, or if they are absent from their home. Fortunately, we are here to break down Inland Revenue’s latest guidance on the matter.

Is the property ‘used as a residence’?

For the main home exclusion to apply the property must be ‘used as a residence’. Inland Revenue adopts the ordinary meaning of these words. A dwelling is ‘used as a residence’ when it is customarily or repeatedly used as a place where a person resides on a permanent basis. It is the seat of their domestic life and interests. Actual physical use is required, not intention or emotional connection.

It is irrelevant if there are reasons beyond the control of the taxpayer that meant they could not use the dwelling as a residence. For example, if a house is flooded and requires extensive renovations where a person must leave for more than 12 months, the main home exclusion may not apply for the full period of the absence, depending on when the property was acquired.

If you are absent, can it still be your main home?

The rules determining how the main home exclusion applies to absences will be different depending on when you acquired the property.

For land acquired from 29 March 2018 to 26 March 2021 (the five-year bright-line test)

The main home exclusion will apply if the dwelling on the land was used as the main home for most of the bright-line period. ‘Most’ means more than 50% of the time – and Inland Revenue draws a hard line: if the land was used as a residence for half of the bright-line period or less, the main home exclusion does not apply at all. No adjustments can be made to recognise periods where the dwelling was used as a residence. On the plus side, provided the property was used as a main home for more than 50% of the time, the property will be fully exempt under the main home exclusion regardless of any period spent living elsewhere.

For land acquired on or after 27 March 2021

Unfortunately for homeowners with newly acquired properties who have post-pandemic itchy feet, the rules are more complex.

Here the main home exclusion applies when all days in the bright-line period are ‘main home days’.

The concept of ‘main home days’ initially seems fitting. Confusingly, however, it also includes days when the land has not been used as a main home – if these days do not exceed 12 months. An absence exceeding this 12-month buffer period is a strong indicator that the dwelling is not used by that person as a residence.

The Commissioner considers that an absence exceeding 365 days does not represent typical use of a dwelling as a residence, although, the exact outcome will be fact dependent. A friend house-sitting while you’re backpacking around Europe is one thing but relocating to London for two years and renting it out is another. If a person relocates and stays in their home whilst visiting twice a year, this would not constitute a fixed or permanent presence, nor would it be typical use of a residential dwelling. The main home exclusion would not apply.

However, an adjustment is allowed for periods where the dwelling was used as a residence (for land acquired on or after 27 March 2021). To put this in a simple example, if a property was acquired in mid-2021, the taxpayer lived in the property until mid-2022 and left for a 2-year OE to London, returning to the property in mid-2024, if the property was then sold in mid-2026, then the main home exemption could apply for 3 years, but would not apply for 2 years; that is, 40% of any income from the property would be taxable under the bright-line.

If you have two or more residences, which is your main home?

The statute reads that, if a person has two or more homes they ‘use as a residence’, their main home will be the one they have the ‘greatest connection’ with.

‘Greatest connection’? How do I know!?

The ‘greatest connection’ test is objective and requires an overall assessment of the person’s circumstances. A person may not, based on emotion (or tax purposes), arbitrarily decide which of their properties they have the ‘greatest connection’ with when applying the main home exclusion.
If you have a family home and a holiday home, you don’t need to worry – the test does not apply because the holiday home is not, typically, ‘used as a residence’ in Inland Revenue’s view.

Inland Revenue has listed several factors to consider:

• the time the person has occupied the home,
• where the person’s immediate family lives,
• where the person’s social ties are strongest,
• where the person’s employment, business interests and economic ties are located, and
• where the person’s personal property is located.
  

None of these factors alone can determine whether a property is a person’s main home, but they can indicate which dwelling the person has the most significant or important bond with.

For example, a person may spend most of the working week in a central city apartment and join a sports club nearby, but their immediate family and possessions are at another property in the country. An overall assessment tends to indicate the country home is likely to be their main home. Factors like their immediate family and personal possessions being there carry more weight. The person probably spends holidays at the country home and has more social ties there as that is where their family is based.

If a person is a New Zealand tax resident, the bright-line test may apply to their overseas properties as well. Therefore, if they spend time overseas and own more than one property, they may also need to consider which home they have the greatest connection with.

Property transactions can be tricky. There have been frequent changes to the bright-line test since it was introduced, we therefore recommend you seek tax advice before selling a property that may be subject to the bright-line. If you have any questions, please contact your usual Deloitte advisor.

May 2023 - Tax Alerts