The property parent trap
Tax Alert - November 2021
By Robyn Walker & Susan Wynne
“The Government is aware of other transactions that can result in an income tax liability arising under the bright-line test, often in the context of family arrangements where the taxpayer is not aware of the potential tax consequences of their actions. For example, parents may help their children onto the property ladder by gifting them residential land or selling it to them at cost. Under the Income Tax Act 2007, section GC 1 deems these transactions to occur at market value. This is an important feature of New Zealand’s tax system to ensure integrity and fairness. However, it can create cash-flow difficulties when an income tax liability arises under the bright-line test.”
The quote above came from the June 2021 discussion document on the design of interest limitation and additional bright-line rules, and possibly may have been the first time alarm bells started to ring for a number of taxpayers who have entered into co-ownership arrangements when buying land.
As highlighted, a common scenario is where parents help their adult children to buy a house. This could be by buying the property and gifting it to them, or becoming co-owners and progressively having their ownership interest bought out. Each of these scenarios could result in an unexpected tax bill.
What are the key rules to be aware of?
In many instances the key issue to be aware of is the application of the “bright-line test”. This rule taxes residential land sales when a property is sold within the bright-line period and no other land sale rules are already taxing the property. The relevant bright-line period depends on when the property was acquired; acquisitions between 28 March 2018 and 26 March 2021 are subject to a 5-year bright-line period, and acquisitions from 27 March 2021 are subject to a 10-year bright-line (unless the property is a ‘new build’, in which case a 5-year period applies).
The bright-line test will tax the income arising from the sale, with an allowance to deduct the costs of the property.
There is an exemption from the bright-line test when the property has predominantly been used as the main home of the person who is disposing of the property.
When there are changes in the ownership of a property, such as changes to the proportionate ownership shares in a property this may result in a disposal and reacquisition by all the co-owners. This can result in a tax liability and restarting the bright-line test period at 10-years again. The outcomes in relation changes in co-ownership are highlighted in a draft interpretation statement issued by Inland Revenue.
If land is sold (or gifted) at an amount below its market value when it would otherwise be subject to tax (e.g. it is sold within the bright-line period), then the transaction will be deemed to take place at the market value of the property at the time of disposal.
It is also worth being aware that if children will be contributing towards the house and paying rental income to their parents (either directly or by paying parents mortgage costs) that this may create additional tax compliance obligations for the parents. Recipients of rental income will need to return this income and consider the residential ring fencing rules and the newly introduced interest limitation rules.
What does this mean in practice?
If a parent owns either all or part of a property which is being occupied by an adult child and subsequently gifts or sells the property to the adult child, the bright-line test will potentially create a tax liability for the parent based on the market value of the property (regardless of the amount paid for the property by the adult child). As the parent won’t have been living in the property the main home exemption will not apply to relieve the parent from tax.
If an adult child is progressively buying out a parent’s ownership interest in the property, each payment could technically trigger a tax obligation. Both parties will be treated as having reacquired their interests in the land each time there is a change in the land title under the Land Transfer Act 2017.
In December 2018, Michaela and Daniel brought a property as tenants in common with their adult son Cameron. The property cost $500,000. Michaela and Daniel own ½ and Cameron owns ½. Michaela and Daniel were required to become co-owners of the land in order for Cameron to secure a mortgage. In October 2021 Cameron come into some money and decides to use this to buy-out part of Michaela and Daniel’s interest in the property. Michaela and Daniel agree that Cameron can buy one half of their interest in the property at cost. Cameron pays $125,000 and now has a ¾ interest in the property. In February 2024, Cameron has met a partner and they are having a child together. At this point, Michaela and Daniel decide to gift their remaining interest in the property to Cameron.
- The sale of the ¼ interest in the property in October 2021 will cause Michaela and Daniel to have income under the bright-line test based on the market value of the property at that time (this will likely be an amount which is higher than the $125,000 received from Cameron).
- In October 2021 the bright-line period will restart again for Michaela, Daniel, and Cameron. The new bright-line period will be 10 years.
- When the remaining ¼ interest is gifted to Cameron in February 2024, this will again result in a bright-line disposal for Michaela and Daniel based on the market value of the property at that time. The bright-line period will once again reset at 10-years for Cameron (noting that if he were to subsequently dispose of his interest in the property, he may be able to use the main home exemption).
The example above is adapted from examples contained in the Inland Revenue draft interpretation statement.
The outcomes above may be surprising and feel like the incorrect outcome when a parent is helping their children. It’s important whenever you’re purchasing property to consider the tax consequences of any anticipated future transactions. There may be options to structure the arrangement in another way (for example by a loan between the parties rather than co-ownership of the land), but in some instances this may be constrained by what is acceptable to the third-party bank providing a mortgage over the property.
Submissions can be made on the draft interpretation statement until 9 November 2021.
Please contact your usual Deloitte advisor if you would like more information.
November 2021 Tax Alert contents
- Significant reporting and disclosure changes looming for New Zealand trusts
- Income tax implications for capital gains distributed to New Zealand beneficiaries through Australian discretionary trusts
- The property parent trap
- PAYE and NRCT simplification coming for cross-border workers
- Are my debt levels subject to the Arm’s Length Test?
- Updated political agreement on global tax reform
- Operational Taxes update: New W-8 series forms – are you ready?
- Snapshot of recent developments