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The Classic Dilemma

The Classic Dilemma

New provisions under the bright-line rules should be studied closely when considering the dilemma around how a trust can distribute losses.

By: Sally Lindsay

6 June 2024

Q. My husband has owned a property for 12 years in his own name with no mortgage, making about $30,000 a year in profit. He is also settlor of our family trust, which owns another property bought on behalf of our kids, unfortunately now making a large loss of about $40,000 a year, with the increase in interest rates and other costs.

The trust owns our family home, which we are paid $13,000 a year in rent for an office for our business which we run from home full time. We have thought about selling my husband’s inner-city Auckland investment property, but it is down in value. However, it’s likely to come back in value quicker than the other property. We are prepared to fund the loss but would like to decrease this to a minimum.

I assume it would be under portfolio rules if we transferred the profitable property and the profit could be offset against the loss of the second rental in the trust. If we sell my husband’s investment property to the trust, would we be subject to the bright-line test if we sold it in the next two years? Neither property was bought for capital gain. His investment property has no mortgage and was bought as a possible retirement home.

A. Yes, your circumstances present the classic dilemma that a trust cannot distribute its losses to your husband to offset the profits he is generating on his own investment. Yes, if the profitable property were transferred to the trust the portfolio basis for loss ring fencing would allow the residential profit on one property to be offset against the loss from the other residential property. This could represent a positive improvement to the overall tax outcome and at the same time facilitate some estate planning and asset protection for the property.

Yes, any transfer like this must be reviewed in the context of bright-line to ensure this issue can be managed without triggering a taxable disposal gain or a bright-line reset. It’s worth noting that on July 1 the bright-line will reduce back to two years, meaning that any property that has been owned for two years will then be out of bright-line.

These new provisions also included an extension of the existing rollover relief provisions that allow some limited rollover relief when a property is transferred between a person and their trust. The new provisions mean that where a property is transferred to an associated entity to the person and that entity has been associated with them for more than two years, rollover relief from bright-line will be available. You should investigate these provisions and perhaps plan to restructure the arrangement when these new provisions come into effect on July 1.

It’s a welcome relief to many that simple family estate and tax arrangements can again now be established without facing unintended consequences from bright-line rules that were only ever introduced to strengthen the purchased with intent to dispose rules in the Income Tax Act.

- Mark Withers

Q. I am a New Zealand citizen working and living in the UK on a youth visa. I have a rental in New Zealand. It was my main home before it turned into a rental before I left NZ. What do I declare in my NZ tax returns regarding wages and rental income?

A. I am going to be able to answer 50 per cent of your query without hesitation but note the other 50 per cent depends on your tax residency status. To explain, rental income from a NZ property needs to be declared, and tax paid if a profit is produced, regardless of whether you are personally tax resident here or not.

The fact that the property is situated in NZ means the rental income has a source here, and as such you have an obligation to declare that income in a NZ tax return. As to whether income you earn from working in the UK is taxable here depends on your tax residency status. If you have lost tax residency in NZ, then income you earn from working offshore will not be taxable here. If you remain a tax resident of NZ, then offshore income may be taxable here, but there is also the double tax agreement to potentially be considered.

In short, this is a more complicated question which involves consideration and application of the tax residency rules to specifics of your circumstances. You should seek professional advice around this.

- Matthew Gilligan

Q. I recently rented out my property to a new tenant, and during the initial viewings the property showcased some chattels, including a large (and heavy) wall mounted mirror that complements the space. However, a month into the tenancy, the tenant wants to remove the mirror to hang their own art. I’m unsure of my obligations regarding this request. Do I have to bear the cost and responsibility of removing, storing and re-installing the mirror? I’ve never encountered such a request before, and I believe the wall-mounted mirror adds value to the property.

A. You’re facing a common dilemma many landlords encounter. Regarding the tenant’s request, you have two viable options. Option one involves agreeing to remove the mirror at your expense, enhancing your relationship with the tenant, but you are bearing the cost and effort. However, I recommend option two, which is treating the situation as a “Tenant’s Request For A Minor Change”. This is outlined in the Residential Tenancies Act (section 42A).

Formalising the request through this process shifts responsibility and costs to the tenant. Have the tenant submit a written request, to which you respond outlining your reasonable conditions, including the requirement to return the mirror to its original position by the end of the tenancy. Ultimately, according to the RTA, the mirror will need to be removed, but following this process ensures clarity and fairness for both parties.

- Ryan Weir

Q. I was wondering about valuations for an off-the-plan investment property purchase requested by the bank as part of mortgage approval and fund release conditions. Does this always need to be done once the property is completed and just before settlement or can it be done based on the plans even before anything has happened on site to mitigate the risk against a drop in price at the time of settlement, which can be months away? Or is it a risk that needs to be accounted for when buying off-the-plan and I need to be ready to fund a drop if the valuation is less than the purchase price?

A. If you had a settlement on an off-the-plan build that was coming up shortly then the bank would probably accept the valuation. However, if settlement is potentially years down the track, then they will want it to be up to date, otherwise it doesn’t reflect the market. An example is while property valuers could probably envision property price drops at the back end of 2021, when interest rates were rising rapidly and property values were clearly inflated, they had no way of knowing how high rates would go so could not accurately value where properties would end up a few years down the track. This unfortunately is a risk you need to mitigate when buying off-the-plan, although in most cases you are likely to be okay now as we have already experienced what should be most of the price drops. While you still need careful due diligence and should get a competent solicitor to go over any agreement, I would personally feel a lot better buying off-the-plans now than two to three years ago.

- Kris Pedersen

Our Expert Panel

Matthew Gilligan Matthew Gilligan is a property investor, developer and tax adviser. He is managing director of chartered accounting firm Gilligan Rowe & Associates, where he heads the specialist property and asset planning divisions. gra.co.nz

Kris Pedersen Kris Pedersen of Kris Pedersen Mortgages is a commentator on property and finance. His team sources top finance strategies. Phone 09 486 4719, www.krispedersenmortgages.co.nz

Mark Withers Mark and his team specialise in advising on property-related transactions, valuation and restructure services, and tax planning. Withers Tsang,phone 09 376 8860, www.pfkwt.co.nz

Ryan Weir Ryan is managing director and franchisor of Propertyscouts NZ. He’s deputy chairman of the RPMA and is passionate about the property management industry, particularly raising industry standards. propertyscouts.co.nz

Shane Campbell A partner in Wynn Williams’ Dispute Resolution Team, Shane specialises in complex commercial disputes. He acts on property disputes, product liability, defective buildings and professional negligence including claims for and against lawyers, architects, accountants, engineers, valuers and property managers. wynnwilliams.co.nz