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The Family Home Can Still Attract Bright-line Tax

Updated: May 17

The Family Home Can Still Attract Bright-line Tax

“Our target is not the family home.” Whilst that might be true, it is not entirely the result achieved.

If you’re selling your main home, you don’t have to pay tax on the sale. But that’s not the entire story, particularly for new builds and homes owned by a trust. Recent changes to the bright-line test mean that properties acquired before or after 27 March, and then sold within 5 or 10 years respectively, are taxed on the gain. This rule does not apply to properties used as a “main home” however, what constitutes a “main home” for the purpose of the exemption is not as straightforward as you might think. There are plenty of people paying tax on the sale of their family home. Here are some of the things you should be aware of before you sell your home.

Firstly, under the previous 5 year rule, your home will only qualify for the main home exemption if you have lived in that home for over half of the time that you have owned it. This requirement has implications for new builds in particular.

The bright-line test for new builds is expected to be kept at 5 years. Here is an example to illustrate the problem:

Chuck purchases land to build his new home. Immediately after he purchases the land construction commences and takes 1 year. Chuck moves into the property as soon as it’s completed and lives at the property for 11 months, when he is offered a job in another part of New Zealand and lists the property for sale. Chuck has owned the property for 1 year and 11 months, and lived in it for 11 months. It is Chuck's only home but, because he has lived in the home for less than half of the time that he has owned it, Chuck must pay tax on his property.

Issues also arise for purchases “off the plans” (for example, a section where title has not yet issued) which you treat as acquiring the property when you enter into a binding contract. It can be many months before title issues, and then there is construction time to think about. It is not unusual for construction to take 9+ months. When land is purchased and title has already been issued, you are treated as acquiring the property at the date of settlement however, again, there is still construction time to consider. Even if you live in the finished home once completed, you need to live in that property for a longer period than you did not live in it, or else you will be paying tax on disposal under the bright-line tax rules.

What happens to the young family who purchase land and build their first home? They wait for title to issue, build their home, live there and then are moved for work, or expand their family and need to upgrade to a larger house. Generally these people do not consider that they might need to pay tax on the sale of their own home. They buy their new home and settle in, then later they receive a letter from Inland Revenue advising they are required to pay tax on the sale of their last home. It is usually the case that they will not have any money saved to pay the tax they didn’t know they needed to pay. Banks generally do not lend for tax, so how does this young family pay their tax bill?

Under the new 10-year bright-line rule there is a 12-month buffer period, but if the property is not the main home for more than 12 months, then income may be attributable to the days that the property is not used as the main home. If the property is not the main home for less than 12 months either side of the owners living there, then the buffer period will apply to save the requirement to pay tax.

An example of how the 10-year bright-line tax rule could lead to tax being paid on the main home is as follows: A person purchases themselves a home but has to move in with their elderly parents to assist with their care. They leave their property vacant so they can return to it, but they end up staying with their parents for a period of over 12 months due to their parents' deteriorating health. If that person disposes of their home within 10 years of acquisition then that person will need to pay tax for the period in which they did not live in the house. The same will apply if someone has a home in New Zealand and then spends time overseas, even if they leave the house vacant while they are away.

Another key area causing people to pay tax on the sale of their own home occurs when the home is owned by a trust. The main home exemption will only apply to the sale of a home owned by a trust if the person living in the home is a beneficiary of the trust and is also the principal settlor of the trust (unless the principal settlor doesn’t have a main home). The principal settlor is the person who has put the greatest amount of value into the trust. They are not necessarily the person listed on the trust deed as the settlor.

Here’s an example to illustrate the problem:

Anton has his home owned by the Anton Family Trust. Anton’s children are beneficiaries of the Anton Family Trust and receive a distribution to purchase a property each for them to live in. These properties are also owned by the Anton Family Trust. Anton is the principal settlor of the Anton Family Trust. Therefore, when Anton’s children sell their home within the bright-line period, they will not benefit from the main home exemption, and instead, will need to pay tax on the profit.

Where property is owned by a trust, only one property (maximum) can be considered the main home for the purpose of the main home exemption. It is not unusual for a family trust to own not only the parents’ home, but also their children’s properties. This removes the ability for their children to benefit from a main home exemption. Further, if the children set up their own trust to own their home rather than the family trust, the parents may still be the principal settlor of the children’s trust as it is often the case that the money to purchase the child’s main home has come from the parents, meaning the parents will be the principal settlor. Careful structuring is required in order to ensure the ability to claim the main home exemption where possible.

Further, under the 5-year bright-line rule, when someone owns their home in a trust and then later rents it out while they live in a new home, even where the person lived in the home for longer than it was rented they may not benefit from the main home exemption. If they had owned the home in their own name they would qualify for the exemption in this case, but because the principal settlor’s main home will not be the one they are disposing of (as they now have a new home) they cannot claim the main home exemption.

The application of the main home exemption to trusts is not new. Many unsuspecting people are getting caught with large tax bills in relatively common situations. These people are not property speculators, but still have to pay tax on their family home. While the target of the bright-line test might not have been the family home, it certainly has captured plenty and there will be many more paying tax on the sale of their family home. If you are thinking about selling your home, or restructuring your assets, make sure you seek legal advice before progressing, as not all issues are as straightforward as you might think.

This article is intended for informational purposes only and should not replace specific tax advice. For personalised advice on all tax issues please contact us.

This article was accurate at the time of publishing.

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