If you own or are considering investing in residential property in New Zealand, you may be wondering how recent changes to the Government's bright-line test, effective 1 July 2024, could impact you. The bright-line test determines whether tax is payable on any profit made from the sale of a residential property within a specified period. Recent changes could impact your investment strategies, particularly regarding the sale and purchase of investment properties. Read on to find out more.
What is the Bright-Line Test?
Essentially, the bright-line test is a mechanism to tax capital gains on residential properties sold within a specified timeframe. It’s used to determine whether tax is payable on any profit made from the sale of a residential property based on the period of ownership.
From 1 July 2024, the period during which a property sale is subject to the bright-line test has been reduced from 10 years for existing homes and five years for qualifying new builds to just two years. That means any residential property sold within two years of its purchase date will be subject to tax on any profit made from the sale.
This shorter bright-line test applies to all properties regardless of when you bought them; not just properties bought after July 1, 2024. If you currently have a five or 10-year bright-line test, it will reduce to two years.
Are there exemptions?
A property is not taxable under the bright-line test provided it meets one of the following exclusions:
- It's your main home and you:
- Use more than 50% of the property’s area as your main home (including the yard, gardens, and garage).
- Live in the property as your main home for more than 50% of the bright-line period.
- If either one of these is less than 50%, then the main home exclusion does not apply, and you will need to pay tax on any profit when you sell it. For example, if you use 40% of a property as your main home and rent out 60% as a flat, you cannot use the main home exclusion when you sell that property.
- It’s used predominately as business premises.
- It’s being used as farmland or capable of being used as farmland.
According to the IRD, inherited property - a transfer of residential property on the death of a person to an executor or administrator of a deceased estate, and the subsequent disposal - is not taxable under the bright-line property rule.
In cases of separation, the bright-line test does not apply to the main home. However, it will apply to any investment properties, including holiday homes, that are sold within two years of their purchase date as part of the relationship settlement.
How are property investors impacted by the change?
Understanding the changes to the bright-line test can help you make informed investment decisions. Here are some practical implications and considerations for property investors:
- Short-term sales: Investors who may be looking to sell properties within two years of purchase will need to factor in the potential tax liability on profits.
- Strategic planning: Long-term investment strategies may need to be adjusted to accommodate the new two-year bright-line test period.
- Family transactions: Be mindful of the extended rollover relief rules when transferring properties within families or associated entities.
Case study example
Jack bought an investment property in June 2022. Under the previous bright-line test rules, Jack would have had to pay tax on any profit from the sale of his property if he sold it before June 2032. This meant that for a decade, any potential profit from a sale would be partially offset by the tax liability.
With the recent changes to the bright-line test, instead of waiting until June 2032 to sell his property without incurring a tax bill on the profit, Jack's obligation now ends in June 2024—eight years earlier than he initially expected.
Jack can now consider reinvesting the proceeds from this sale into other properties or investment opportunities sooner than expected, potentially accelerating the growth of his investment portfolio.
Jack’s case illustrates the substantial benefits of the bright-line test changes for property investors. By shortening the bright-line test period, the new rules offer more flexibility, reduce financial risks, and potentially increase returns on investment.
Property investment advice
If you’re a property investor like Jack, work with a Mortgage Express mortgage adviser to understand how to leverage these changes to your advantage. Get help navigating the bright-line test and other rules – including the return of interest deductibility for property investors, optimise your investment strategies, and make informed decisions for your property investment journey.
