Thousands of New Zealanders will be faced with paying a capital gains tax of up to 39 per cent on what many consider a family home under a new interpretation by the IRD of the Government’s sweeping 2021 changes to property taxes.
Those changes meant that if an investment property was sold within 10 years of being purchased, it was captured by something called a bright-line test, and hit by a capital gains tax.
It only hit investment properties, excluding the family home. But an IRD interpretation of the rules, which went out for consultation earlier this year, and will shortly be published with few changes, sets out a definition of a family home and investment properties that has tax experts scratching their heads.
The rules lump what many would describe as “family homes” - or a main home, to use IRD’s terminology - in with investment properties, meaning that many people who only own one home and do not think of themselves as investors, will be hit.
The rules state that even if a person owns only one home, and their spouse and school-age children live in that home the whole time it has been owned, they will be hit with the tax if they spend 12 months or more away - even if their spouse and children stay living there, and they continue to visit.
The IRD’s interpretation document is designed to help tax lawyers and accountants implement the existing rules. It is not a new set of rules, but an official IRD interpretation of existing ones. The rules have been law since 2021.
One tax expert is warning that the rules are so broad, some households might not even know they are subject to them, particularly as the Government has marketed the taxes as only applying to property investors and millionaires, rather than working parents, professors, teachers, police, people who serve in the military and labourers, who are likely to be hit by the rules if they are forced to relocate and travel for work.
The rules effectively subject people who work in professions that mean extended periods away from home to incredibly high effective tax rates.
Homeowners may find themselves hit with shock tax bills, when they sell, that prevent them from buying a house in the city they live in, or find themselves subject to the tax because they moved out of their cyclone- or earthquake-damaged home while it was being repaired.
National’s Nicola Willis called the rules a “capital gains tax by stealth” and promised to repeal them, returning to the settings that were introduced under the John Key Government.
“New Zealanders can’t trust Labour on tax. Grant Robertson promised when he introduced this extension that it would not affect the family home,” Willis said.
A spokeswoman for Revenue Minister Barbara Edmonds said a final version of the IRD interpretation would be published in a couple of weeks.
“The minister expects officials to advise her on any policy issues raised that may need consideration,” she said.
However, an IRD spokesman confirmed the Tax Commissioner had not changed their interpretation of the rules relating to the example of how the tax applies when a spouse and children continue to live in the home - the tax still applies.
The problem dates back to 2021, when the Government extended the bright-line test to 10 years. The bright-line test is a capital gains tax on homes sold within the bright-line period. It was brought in by the Key Government, which set the bright-line period at two years and excluded the family home from being affected. Labour extended it to five years in its first term, fulfilling an election promise.
In March 2021, the Government extended the period to 10 years, without including the change in Labour’s manifesto for the election six months prior. At the same time, the Government changed the definition of a “main [or family] home”, broadening the number of homeowners affected. A 10-year bright-line test is a lot closer to a de facto capital gains tax because 64 per cent of properties are sold within 10 years of being purchased, according to a Regulatory Impact Assessment.
The changes were rushed. They were announced on March 23, and took effect on March 27, after being included in a tax bill already before the House.
The rules are meant to target property investors, but the way an investor is defined captures what many people would describe as the family home.
The issue has resurfaced recently thanks to guidance published earlier this year by the IRD on how the rules work in practice.
The IRD’s interpretation says that a person’s capital gains are captured by the tax if they are away from the home for 12 consecutive months or more in the bright-line period - even if the home is the only residential property they own.
An example used by the IRD says that even if someone’s spouse and school-age children live in the house for the entire time they are away, they are still captured by the rules, making them liable for tax on their capital gains of up to 39 per cent - one of the highest rates of capital gains tax in the world.
For most sellers, the tax would be 33 per cent on any liable gains.
Even though the rules have been in force since 2021, the definition of what qualifies as a family home (a “main home” in the rules) has been difficult to pin down.
An example used in the IRD interpretation is that of “Rebecca”, a woman who owns an Auckland apartment with her husband and lives in it with two school-age daughters.
Rebecca is forced to work away from Auckland for two years. She never buys a second home. Instead, she is put up in accommodation by her employer. Her husband and daughters continue to live in the apartment and Rebecca comes back twice a year to visit them.
Despite never owning an additional home, and having her husband and daughters stay in the sole home she owns, Rebecca has to pay tax on her capital gains for the time she was away from her home.
An IRD spokesman confirmed that this example had not changed, following consultation, as the feedback on it had been positive.
The spokesman said the submissions received on the documents “largely agreed with the commissioner’s interpretation of the existing law”.
On the example of “Rebecca”, the number of submissions that agreed with the interpretation meant there was “no change to the outcome of that example”.
An IRD spokesman said the consultation document “set out the commissioner’s view on how the law applies”.
“We have nearly finished our review of all the comments and will be amending the items accordingly,” he said.
“Where the submission raised policy concerns about the law, those are being passed on to our Policy area,” he said.
Deloitte tax partner Robyn Walker said that in the “Rebecca” scenario, most people would think the apartment is Rebecca’s “main home”, and therefore not subject to the tax.
“I think you could definitely say that the rules capture more than what people would intuitively think should be captured,” Walker said.
“Most people think that they should be fine if they’ve been living in the house - that they don’t need to worry about the bright-line test because they have this main home exemption to rely on,” she said.
“What we’ve had with the most recent set of changes to the bright-line test is the main home exemption has gone away from, ‘has the, the property been mainly used as the main home?’... to now having a scenario that if you’re outside of the property for more than 12 months, then you are caught by the bright line.
“If you owned the house for nine years and you sold it and you lived in it for seven years, you would be taxed on two years.”
OliverShaw tax partner and member of Labour’s Tax Working Group, Robin Oliver, said the tax would have consequences for people who sell their homes and try to buy again in the same market - if, for example, they need an additional bedroom for their growing family.
“You just don’t have the money to buy a new house. If house prices have gone up 50 per cent, you’re paying tax on that but someone else is not,” Oliver said.
“It’s not real money you’re making, you’ve not made a real gain because you’re buying in the same market,” he said.
Oliver cited an even tougher example - someone forced to evacuate their home for more than 12 months while it is repaired following the floods and cyclone this year would be hit by the tax unless they were able to claim one of the complex exemptions for building.
“Say you’re from Piha and you have to evacuate [for more than 12 months] - well, tough,” he said.
Willis said that National had warned in 2021 the rules would have unfair consequences.
“This example precisely illustrates the problem. Kiwis should not be punished for taking an overseas secondment or having to move temporarily to deal with a family emergency,” she said.
“We warned Labour that their changes to the definition of ‘main home’ would have unfair consequences for people who have to relocate temporarily and that extending the bright-line test to 10 years would capture people that the test didn’t intend to capture when it was first introduced at two years.”
Act leader David Seymour said he had always disagreed with the bright-line test, even when it was introduced by National.
“I sat on FEC [Finance and Expenditure Committee] when National introduced this law. I said it would be a never-ending circus. I said Labour would increase it to five and 10 years and they have.
He said it created “endless compliance activity” that soaked up time and resource from the productive economy.
How the bright-line test works:
- The bright-line test taxes capital gains you make on a home sold within the bright-line period, currently 10 years. It is meant to capture investors, mainly people who own two or more properties
- The tax rate you pay is your marginal tax rate.
- Family homes are excluded from the rule. If your home qualifies as a family home, you pay no tax.
- But some “family” homes are actually “investor” homes under the rules.
- Even if you only own one home, and the home is occupied by your partner and children, the home is subject to the tax if you spend 12 months or more away from it - even if you come back and visit during those 12 months.
- The amount of tax paid is determined by the amount of time out of a home.
- If a family moves out of the home for essential repairs for 12 months, after a natural disaster like a cyclone or an earthquake, gains from the home are still subject to the bright-line test. Gains made after that home is sold will be taxed.
Rachel - an example used by the IRD:
- Rachel has an apartment in Auckland she buys in 2021.
- She lives in the apartment with her husband, Luke and two school-age children.
- She is seconded overseas to the Middle East for two years, leaving her husband and children living there. While abroad, she stays in employer-provided accommodation. She returns twice a year.
- When she sells the home, her share is subject to a capital gains tax for the time she was away.