Legal focus: The ‘extended’ bright line test
Have you heard the one about selling a house within five years of buying it and then being taxed on the profit?
Unfortunately, this is not a joke.
Since 2015, there have been rules – known as the bright line test – which govern when the sale of a property is likely to give rise to a tax liability. From March 2018, those rules have been extended and the opportunity to be found liable for income tax on a sale is even greater than before.
The bright line test did not apply prior to October 2015. If you purchased a property before then, the rules will not apply to you, no matter when you sell. You might still be taxed on the sale, but only if you are shown to have bought the property with the intention or purpose of resale. This has traditionally been difficult to prove.
However, with the introduction of the bright line test, intention became irrelevant. If you purchased a property and sold it within two years, you would have been taxed on the gain you made on the sale.
Following a recent legislative extension to the rules, if you purchase a property after 29 March 2018, and then sell it within five years, you will be taxed on the gain.
Thankfully, the rules don’t apply to every transaction. They only apply to residential land – not business premises and farmland. They also don’t apply to your main home. Having said that, you can only use the main home exclusion twice over any two-year period. And, the main home exclusion does not apply if you show a regular pattern of buying and selling residential property.
We are often asked whether these rules apply if your home is owned by a Family Trust. The answer is yes. Here are a few examples how: If you elect to transfer a property to a Family Trust and the Trust chooses to sell that same property three years later, the trustees of the Trust could equally be held liable for income tax on the gain.
However, the trustees can generally use the same main home exemption as private individuals, providing the property owned by the Trust is used as the beneficiary’s main home for most of the time that the Trust owns the land.
Also, if the family trust owns a property, and the title to the property needs to be transferred as a result of a change in trusteeship, the change in names of the trustees will not cause the bright-line rules to come into effect and will not trigger a tax bill as a result of that change.
But that still leaves plenty of scope to be caught.
If the Trust purchased a rental property on 1 April 2018, and sold it within 5 years, the bright line test will apply. If the Trust makes a profit on the sale, that profit will be taxed.
The idea behind the rules is to help dampen property speculation and make homes more affordable. They can, however, trip you up unexpectedly. Perpetual Guardian have a team of professionals who are trained to spot the red flags. We can let you know if a transaction is likely to fall foul of the bright line test and result in an unforeseen tax bill.