We are seeing unprecedented levels of activity in the property market. The team at Walsh & Associates have put together a comprehensive guide to support our clients in making good decisions when it comes to Property.
1. Property Taxes
It is worthwhile keeping in mind when buying, selling or transferring property that there may be unintended tax consequences.
Often, we only find out about potential tax problems from clients when it is too late, and the deal has already been done. Once a property is under contract there is a legally binding agreement in place. Depending on the conditions and clauses it can be very difficult to back out of a purchase if problems occur.
Did you know the Inland Revenue Department (IRD) have a Property Compliance Team?
Way back in 2008 the team was established to review compliance risks with property development and speculation. In 2015 the Government pledged additional funding to the of $6.65 million per annum for a period of 5 years to the IRD to focus on residential property speculation.
The IRD has access to all property transactions completed through Land Information New Zealand (LINZ). Where potential risks are identified the Inland Revenue Department may contact the seller of a property (or their tax agent) to remind them of the next steps they must take.
Property Investor or Property Trader/Developer?
Unfortunately, we see too often that property investors are tarred with the same brush as property traders and developers. A prime example of this is the application of the Brightline Test which came into force on 1st October 2015 and more recently the Ring Fencing laws.
So, what is the difference between a property investor and a property trader or developer?
A property investor purchases property for long term rental. Many clients we work with employ this strategy as part of their retirement savings plan.
A property trader or developer on the other hand is in the business of buying and selling or developing land for a profit.
Where is specialist advice needed?
Here are some of the situations we come across where specialist advice is recommended:
- selling residential property with certain timeframes
- transferring property between trusts
- purchasing land for the future (land banking)
- builders building spec houses
- property investors also involved in property trading/development
- farmers subdividing land
- property change of use
- People associated to a dealer, developer or builder
- Selling shares in a Look Through Company (LTC)
We often find when providing consulting advice that several sub-sections of the Income Tax Act 2007 could be applicable to a client’s circumstances and need to be worked through. Aside from income tax (which includes the Brightline Test and Ring-Fencing laws) clients unbeknown to them may end up finding themselves liable for GST, Non-Resident withholding tax and income tax and capital gains taxes imposed by other countries.
As your trusted tax advisor, we are here to help put your mind at ease should you find yourself in one of those situations mentioned earlier.
2. The residential property “Intention Rule”
Most people purchase a residential property they would like to sell at some point in the future. Care needs to be taken to document what the intention is at the time of acquisition.
Section CB 6(1) of the 2017 Income Tax Act requires income tax to be paid on the profit from the sale of residential if there was an intention of resale at the time of acquisition. This can extend to your own home, not just rental property.
There are only 2 exclusions from Section 6(1) being the Residential Land Exclusion and the Business Premises Exclusion
Residential Land Exclusion (s CB 6 Section CB 16)
If the land has a house on it, or you build one, and you occupy the house mainly as a residence, the taxpayer will not be taxed under s CB 6 on the proceeds from selling the property.
The area of the land has to be 4,500 square metres or less, or if it is bigger, the larger area has to have been acquired for the reasonable occupation and enjoyment of the house.
This exclusion can’t be used if there has been a regular pattern of acquiring and disposing of houses or building and disposing of houses.
Business Premises Exclusion (s CB 6 Section CB 19)
Where business premises that are acquired and occupied or built and occupied mainly to carry on a substantial business from them the taxpayer is unlikely to be taxed under s CB 6 on the proceeds from selling the property.
The land and the premises have to be reserved for the use of the business, and the area of the land can be no greater than that required for the reasonable occupation of the premises and the carrying on of the business.
How does it work in practice?
If a taxpayer is determined to be liable for income tax on the proceeds of selling land, they can deduct the cost of the land, any capital improvements made to it and any others costs connected to the sale process (i.e. advertising, real estate commission, legal expenses). Tax is then paid on the net taxable income at the taxpayer’s marginal tax rate.
But what if?
What factors determine intention? Whether there was an intention of disposing of the property when it was acquired is subjective. What a taxpayer says and does will be assessed against all of the evidence to clarify intention.
What if there are multiple intentions for acquiring the property? The intention to sell does not need to be the main reason for acquiring a property. It could be one of a number of reasons for buying. It also does not need to be the main or dominant intention either. The intention has to be more than a vague idea or possibility though to be taxed.
What if a taxpayer tries to deceive Inland Revenue Department? The intention is only relevant at the time of acquisition. This however includes the whole of the acquisition process from when it was first decided to acquire the property. Also, if a taxpayer’s actions following an acquisition contradict what the taxpayer said this may also be taken into consideration
What if the taxpayer believes they are right? The onus is on the taxpayer to prove to Inland Revenue Department they did not acquire the property with the intention of disposing of it. If for example at the time of acquisition the tax payer had no firm intention to dispose of the property it is unlikely they will be taxed on the proceeds of its eventual sale but the taxpayer will have to show this is the case.
What if the taxpayer changes their mind and decide not to sell the land? If the property was acquired with an intention of disposing of it, but the taxpayer changes their mind and decide to do something else (e.g., rent the property out), they will still be taxed on the proceeds when they eventually sell it.
How can a taxpayer protect themselves?
It does not matter when a taxpayer sells a property if there was a firm intention to dispose at acquisition so it’s vital to ensure taxpayers document their intention in writing. This includes;
- In conversation and correspondence with lending institutions, real estate agents, mortgage brokers, accountants
- Minutes of board meetings
- Resolutions of directors or trustees
Even if a taxpayer disposing property can satisfy the requirements to avoid being caught by the “intention rule” the disposal maybe still be subject income tax in one of the following situations;
- there is a clear pattern of buying and selling;
- under the Brightline Test.
- being associated to a dealer/developer/builder.
- buying and selling for a profit.
A taxpayer should consult with their tax advisers before carrying out any land transactions if they think there is a chance they could be taxed on the eventual sale under one of the above scenarios.
3. Using and/or Nominee in sale and purchase agreements
With the buoyant property market, we are currently within it is vital that any property purchased is recoded in the correct entity at the time of that purchase. This will avoid further costly restructuring later both in legal terms and taxation matters.
What does the use of the term “and/or nominee” mean?
A purchaser can sign agreements allowing one party to sign the physical agreement for the purchase, whilst reserving the ability to register the actual owner of the property recorded on the title deed in another. This is essentially an “assignment” of the purchaser’s rights.
Both the standard agreement for sale and purchase of a business and agreement for sale and purchase of real estate allow a purchaser to “nominate” another entity to carry out the purchase on their behalf.
How is this done?
By leaving the phrase “and/or nominee” open after the name of a purchaser on the agreement.
Why would you do this?
- Flexibility – It can save time and hassle of getting multiple parties to sign the agreement if one person is negotiating a purchase.
- Choice – The prospective purchaser maybe unsure which legal entity will complete the purchase at the time the agreement is signed. This then gives them a future option if they wish to form a company or trust to complete the purchase.
An agreement for sale and purchase of a business or real estate is a legally binding agreement. By including the words “and/or nominee” in the description of the purchaser avoids any doubt as to whether the nominee can enforce the agreement.
Always ensure your solicitor and accountant are informed of the entity that the property or business is going to be settled in to well in advance. Your accountant will be able to assist you with advice on what type of entity is appropriate for your circumstances. Your solicitor will prepare Deed of Nomination forms that are required to be signed by the officers of the entity the property or business is being settled into.