Property tax trap – a cautionary tale for co-ownership

The tax rules affecting property ownership have become increasingly complex in recent years, particularly for those in the residential property space.

The latest Inland Revenue commentary to be finalised on the land sale rules is Interpretation Statement IS 22/03 “Income tax – Application of the land sale rules to co-ownership changes and changes of trustees”. IS 22/03 considers how the land sale rules in the Income Tax Act 2007 (ITA07) apply to changes to co-ownership and changes of trustees of a trust.

The focus of IS 22/03 is on situations where ownership of property is shared and if a disposal of property for tax purposes occurs that could trigger the taxing provisions in the ITA07. For example, the bright-line test which can apply if you sell residential land within a certain period or if you acquired land with the intention of selling it.

Broadly IS 22/03 confirms that where the proportional or notional share in the property (e.g. 50:50) doesn’t change, regardless if there is a change in the type of co-ownership, there shouldn’t be a disposal under the land sale rules. In contrast if the ownership share in a property does change (e.g. from 50:50 to 25:75) there is a disposal under the land sale rules for the owner reducing their ownership interest.

Generally, the commentary in IS 22/03 is helpful but doesn’t go as far as fixing difficulties that arise when you overlay land taxing provisions, particularly in the common scenario where parents help their adult children to buy a house. For example:

• The “bright-line test” taxes residential land sales when a property is sold within the bright-line period and no other land sale rules apply to tax the property. The relevant bright-line period depends on when the property was acquired as follows:

o Acquisitions between 28 March 2018 and 26 March 2021 are subject to a 5-year bright-line period;

o Acquisitions from 27 March 2021 are subject to a 10-year bright-line (unless the property is a ‘new build’, in which case a 5-year period applies).

If an adult child is progressively buying out a parent’s ownership interest in a property, each change in ownership share would be a disposal for the parents and could re-set the bright-line test applying and the bright-line start date. Specific provisions came into effect on 27 March 2021 to ensure that the bright line clock only restarts to the extent that an owner’s interest has increased and not for any share already owned. However, clarification around which bright-line test will apply in a situation where a share of residential land was acquired before 27 March 2021 (subject to the 5-year bright-line test) and subsequently an additional share is acquired on or after 27 March 2021 (subject to the 10-year bright-line test) is still required.

• There is an exemption from the bright-line test when the property has predominantly been used as the main home of the person who is disposing of the property. This exemption will not apply to co-owners who do not live in the property, such as parents helping children onto the property ladder.
• If land is sold (or gifted) at an amount below its market value when it would otherwise be subject to tax (e.g. it is sold within the bright-line period), then the transaction will be deemed to take place at the market value of the property at the time of disposal. If an adult child is progressively buying out a parent’s ownership interest in the property, each payment could technically trigger a tax obligation depending on the transfer price.

In summary the land rules have become increasingly complex and difficult to apply, particularly for residential properties. With recent reports putting the “Bank of Mum and Dad” as New Zealand’s 5th biggest home loan lender it is important for all parties to consider their options and structures before entering any lending or ownership arrangements. Especially if the Bank of Mum and Dad takes an ownership interest in a residential property.

It will also be interesting to see if comments made in the June 2021 discussion document that the Government is interested in undertaking more work around family arrangements impacted by the bright-line test will result in any action in the near future.