Will the bright-line test changes affect separating couples?

There has been a lot of publicity recently regarding the extension of the bright-line test from 5 years to 10 years.  The bright-line test applies to all residential property, other than the main dwelling. If a property is sold within 10 years of acquisition, any capital gain is taxable.

So when parties separate, the bright-line test does not apply to the main family home, but it will apply to any investment properties or a holiday home.

Relationship property exemption

When parties separate, real estate is often the main relationship property asset to be divided between the parties. Often one party to the relationship hopes to buy out the other party, but in New Zealand’s expensive (and rising) property market, that is not always possible, leading to the property being sold to a third party.

If the parties can agree to take one property each (or split them equally if there are more than two), they will not have to pay tax, as the bright-line test does not apply when a property is transferred under a relationship property agreement. However, this only applies when the property is transferred between the parties; if the property is sold to a third party, the bright-line test will apply if the parties have owned the property for less than 10 years and it is not the main home.

Although taking one property each is sensible in theory, it may not be workable in practice if one property is a holiday home and located away from the parties’ workplaces or the children’s schools. If neither party can afford to buy the other out, the property will have to be sold and any capital gain will be subject to tax. With New Zealand’s rapidly rising house prices, the parties may be reluctant to sell the house and pay potentially substantial amounts of tax on the capital gain. If the parties are on good terms, they may wish to consider entering a property sharing agreement until they can sell the property tax-free.

Factoring tax into settlement agreements

Where the other property is an investment property, it may be easier for one party to take the family home and the other to take the investment property and use it as their new family home. However, this has the potential to put the party taking the investment property at a disadvantage if they want to later sell that property within 10 years of acquisition. The new changes mean that if the home was not used as the main home for more than 12 months during the applicable bright-line period, the owner will have to pay tax on a proportion of the capital gain. This means that when a relationship property settlement includes property that is not the main house, the parties will need to consider tax implications when dividing their property.

If you have any questions relating to this article, please contact one of our specialists.