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Bright-Line Extension

Be aware of the changes and protect your investment from the five-year bright-line test. By Matthew Gilligan.

By: Matthew Gilligan

1 April 2018

By the time you read this, it is more than likely that the brightline rules will have changed, which will affect you if you are planning to buy or restructure investment property.

You are probably already familiar with the two-year bright-line test that was introduced in October 2015. Under this test, investment property that is sold within two years of settlement is subject to tax on any increase in value.

The Labour Government has always said they will extend this test to five years. On 15 February it was announced that the five-year rule will apply to residential land acquired where the contract is entered into on or after the day that the new Act receives Royal assent. This is expected to happen in March 2018.

Therefore, while there is no exact date specified, there is only a limited time that the two-year bright-line rule will remain in force. Once Royal assent is granted, investment property purchases made after that date will be subject to the five-year bright-line rule.

There seems to be some general confusion around the extension to bright-line rule and under which circumstances it will apply. The case studies below should help to clarify. In both these examples, we will assume the five-year bright-line rule comes into effect on 18 March 2018 (as at time of writing we don’t know the exact date, but it is useful to illustrate the point.)

Case Study 1

Simon buys an investment property, entering into the contract to purchase on 1 April 2018 with settlement set for 30 April 2018. He pays $1m for it, and his intention is to hold it as an investment property long-term. Four years later he sells the property for $3m, making a $2m gain.

In this case, the five-year bright-line period applies, because the contract was entered into after the date of Royal assent. The five-year clock starts from the date of settlement (30 April 2018). Therefore, despite the property being acquired as a long-term investment, Simon is caught under the five-year bright-line rules and the gain is taxable because he sold it within five years.

Case Study 2

Margaret decides to purchase an investment property entering into a contract to purchase on 15 March 2018. The contract is conditional on LIM and finance. These conditions are subsequently confirmed and the contract declared unconditional on 25 March 2018. Settlement takes place 30 April 2018. Margaret sells the property four years later.

In this case the two-year bright-line period applies because the contract was entered into before the date of Royal assent. It does not matter that settlement occurred after that date. It should also be noted that generally a conditional contract is enough to be regarded as entry into the contract, but it does depend on the conditions. Since she acquired the property with long-term intent and has owned it for more than two years post settlement, she does not have to pay tax under the bright-line rules.

So there are two elements at play.

Firstly, when is the contract entered into? This determines whether you are subject to the two-year or five-year bright-line period.

Secondly, have you sold within the bright-line period? This runs either two or five years from the date of settlement. Note that there are exceptions on this rule in that sometimes the bright-line clock starts ticking on entering into the contract rather than settlement date (e.g. off the plans purchases).

Bear in mind that the bright-line rules apply to residential property and there are exemptions, including the family home. Determining whether the brightline test applies to your situation (and therefore whether you have to pay tax) can be confusing.

If you are acquiring a new asset, ensure you have the right structure at the outset to avoid expensive restructure costs later. (If you move the asset within five years and make a gain, you will have to pay tax, even on related party sales.)

When restructuring, assets being moved must be examined for potential
taxable gains on restructure or in the future if you intend to re-sell them within five years. You might be better to do nothing (if the market is growing rapidly around the area you hold the asset in), or you will risk paying tax on the gains.

Talk to us if you are not sure – it’s important to get this right.

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