Some time last month, the government has come up with a raft of policy changes designed to cool our overheating property market. One of the tools they have proposed is to double the term required for the bright-line test from 5 years to 10 years.
Bright line test? What’s that?? I hear you say!
So in today’s article, I will answer some of the common questions about the bright line test:
What is the bright-line test?
Great question!
The bright-line test is the test applied by the IRD to determine if a property sold is liable for income tax or not.
Prior to the government’s announcement – any gains made on property sold is liable for income tax if:
- It was sold within 5 (now 10 years, if you have purchased the property after 27 March 2021) years of you purchasing the property
- It is not your ‘own home’ – note that this exemption usually only applies to one property and can only be changed once every 2 years.
This basically means, you will be earning above what you normally would earn within the year because you sold the property. In most cases, this means that any gains on the sale of the property will cause your annual income to jump up and into the 39% tax bracket. You can read about how to calculate income tax in this article.
Let’s take an example:
Mindy sells a property she purchased 4 years ago for a gain of $300,000. During the year she earned $100,000 from her job as a sales manager. Normally she would have an effective tax rate (the average tax she pays) of about 23% from her annual income of $100,000. With capital gains income, her effective tax rate jumps up to about 34% for the year. YIKES!
Why are property owners angry about the doubling of the bright-line test?
As you would expect, individuals with lots of money stashed in property are upset that they won’t be getting as much of their money back if they decide to sell within the 10 year period.
But, I mean, they’re STILL making money – just not as much they would have expected to.
Prior to the rule change,property investors would have to time their sales to coincide with the expiration of the 5 year date – now they have to time it to coincide with the expiration of the 10 year date. In other words, if they sold before that 10 year date by even one day, they have to pay income tax on the capital gain.
But, the bright-line test isn’t capital gains tax? Right?
WRONG.
It IS a form of tax on capital gains.
No matter how much the NZ government tries to ‘not implement Capital Gains Tax’ the bright-line test has always been a tax on capital gains. It’s just not a very smart one.
Check out this article about a Capital Gains Tax that scales with how long you’ve owned the property. This is a fairer system that taxes capital gains, but without such an arbitrary cut-off point.
It feels like the only reason why we can’t have a smarter way to tax capital gains is because the government (and the opposition too, I might add) has promised not to implement Capital Gains Tax while they are in power. Apparently it’s smarter to pretend the bright-line test isn’t a tax on capital gains and just use that.
Will this cool the property market?
Maybe? But my opinion is that it will make property less attractive for short term (less than 10 years) investment. That’s about it really. Gains from rental income and general capital appreciation will still be attractive. It won’t cause property values to drop, but it means that investors could look at other investments instead of tying everything up in property.
Will renters finally be able to afford their first home?
I don’t know – every individual has different financial circumstances. Apart from the doubling of the bright-line test, the government has signaled more policies, like removing interest deductibility to cool the property market. Ultimately, it is a question of supply and demand – and right now, there is more demand for housing than there is supply.
Will evil foreigners finally stop buying up our homes?
Haha – No. Property in NZ are still attractive long term investments, since they can still be sold for no tax at all (after 10 years).
Also, if you think all foreigners are evil – go jump in a lake.
What happens now?
From a tax point of view – us accountants will be telling our clients to hold off on selling their properties until the expiry of the 10 year rule, because our job is to help them pay the most efficient amount of taxes and abide by the rules. This means that existing property owners will keep their properties (unless they are motivated sellers). Alternatively, they could increase the asking price to cover the tax they would have to pay.
The new ruling could discourage new investors from investing in property, but given that NZ property has a pretty stellar reputation for growth, I don’t really see this impacting demand to invest in property, especially since it can still be sold tax-free after 10 years. So overall it probably won’t impact property prices that much.
In the meantime, all us renters and prospective first home buyers (that’s me at the time of writing this article) will have to continue stashing cash away for our first home deposit (however long that may be) or rely on wealthy relatives to help us get on the property ladder.
Kia Kaha NZ – we’ll make it through this housing crisis yet!