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R&M on the residential property rules

Tax Alert - September 2022

Spring is a popular time to tidy up your property, so it is timely that the recently legislated residential property changes (the interest limitation rules and bright-lines test) are also getting a tidy up; perhaps reflecting their hasty construction and build.

Most of the changes proposed in the Taxation (Annual Rates for 2022-23, Platform Economy, and Remedial Matters) Bill are taxpayer friendly or allow the rules to operate as planned where the original legislation was not clear or did not give the desired result.

The “bright-line test” taxes residential land sales when a property is sold within the bright-line period (currently either five or ten years) and no other land sale rules apply to tax the property. Rollover relief from the bright-line test allows certain transfers of property to be ignored and for the recipient to take on the original owner’s acquisition cost and date. Once enacted, the fixes to the rollover relief rules should allow a residential property to be:

  • Transferred from a family or Māori trust back to the settlors of the trust, regardless of whether the property was transferred into the trust by a settlor or purchased by the trust. Noting that certain conditions must be met. The requirement that a settlor receiving the property must be an original settlor has also been removed.
  • Resettled from a family or Māori trust to a new family or Māori trust provided there is the required association between both trusts’ settlors and beneficiaries.
  • Transferred from a family or Māori trust back to the settlors of the trust in a different capacity, e.g., to a look through company or partnership they are the owner or partner in provided there is no intervening transfer to a third party.

The rules have also been clarified to ensure that where rollover relief applies the start of the bright-line period does not reset (e.g., when the clock runs from) and the original bright-line test rather than the test applying at the time of transfer applies to recipient (e.g., the five or ten year test).

Care should be taken around applying these updates to property transfers, as some changes will apply from 27 March 2021, some will apply from 1 April 2022 but the rest will take effect after the Bill introducing the changes receives royal assent, expected to be late March 2023.

The interest limitation rules apply to residential rental property owners claiming tax deductions for interest on the borrowing for their rental properties. Rollover relief for interest limitation purposes applies in the same situations as the bright-line rollover relief, so will also apply more broadly. The rollover relief should allow loans and interest deductions to be treated by a new owner in the same way as the original owner provided the required conditions are met.

Residential property developments that qualify as a build-to-rent development will be completely excluded from the interest limitation rules (compared with the 20 year exemption for new build properties). This is intended to apply to new and existing developments who met the requirements for the exclusion, being:

  • The relevant land together with attached or adjoining land owned by the same person has 20 or more dwellings; and
  • Each dwelling is used, available for use, or being prepared for a residential tenancy, with an option of a 10-year term, the ability to give 56 days’ notice of termination and the tenancy agreement includes a personalisation policy.

A development must continuously meet the requirements of the definition of “build-to-rent land” summarised above to qualify for the exemption. Existing developments have until 1 July 2023 to meet the definition requirements which would apply retrospectively allowing any interest deductions denied from 1 October 2021 to be claimed. Those wanting to qualify for the exemption would need sign-off from the Chief Executive of Te Tāūpapa Kura Kāinga – Ministry of Housing and Urban Development.

The bright-line rules apply where there is a disposal of residential land. Where residential land is co-owned Inland Revenue commentary (IS 22/03) confirms that if the proportional or notional share in the property (e.g. 50:50) doesn’t change, regardless of whether there is a change in the type of co-ownership, there shouldn’t be a disposal under the land sale rules. If a co-owner is added or removed (e.g. from 50:50 to 25:75) there is a disposal for the owner reducing their ownership interest. The wording of the tax legislation concerning changes in co-ownership of residential land is being updated to reflect that a change in the legal form of co-ownership, for example from joint tenants to tenants in common or vice versa, is a conversion rather than an acquisition.

A helpful change is the clarification that when a person acquires different part shares of a residential property at different times and later sells the property, the bright-line test length (e.g. zero, two, five or ten years) that applied when they first purchased an interest in the land will apply to all of the sale. This is achieved by the introduction of a new section that provides the ten year bright-line test does not apply where a person first acquired an interest in the land before 27 March 2021. The different acquisition dates will still mean a different start date applies for counting the bright-line period for each share of the land.

The definition of “disposal” is being amended for the land sale rules to exclude the allocation of subdivided land among co-owners. This applies to situations where taxpayers may purchase land together, subdivide the land and allocate the subdivided land to each co-owner based on the ownership interests in the original undivided land. The exclusion applies for the bright-line test and other land sale provisions. It will only apply to the extent that there is the same economic ownership by the parties before and after the transfer. Any difference, including wash up payments between parties, may to be subject to tax (where applicable) on the basis there has been a change in economic ownership and a disposal of land.

The extent of the changes being proposed to tidy up the residential property tax rules demonstrates that these are no longer simple to apply, and the devil is indeed in the detail. Of concern is that if the architects themselves are unable to get the design right so the rules work, how is the average homeowner expected to comply with the rules? It may be a better to go back to the drawing board to design something more fit for purpose rather than simply patching up a shoddy build.

If you have any questions around residential property and how the tax rules may apply to you, please contact your usual Deloitte advisor.

September 2022 - Tax Alerts

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