Property problems: Intent determines taxes on property sale profits

Q. I have had a small property in Christchurch for four years. I lived in this property for the first 18 months, then let it through a rental agency while I travelled overseas. I sold the property in January. What taxes will I be liable for on the profit I made on the sale? How do I work out these taxes?

A. No part of the profit made on the sale of a rental property in these circumstances is necessarily subject to income tax.

Whether income tax is payable will depend on other facts surrounding your purchase and/or treatment of the property since you bought it.

If you bought the property intending to re-sell it, rather than hold long-term, income tax will be payable on the profit - generally the sale price less purchase price and costs of sale.

A sale four years after purchase does not necessarily indicate that you acquired the property for the purpose or intention of resale. But it is the intention or purpose at the time of acquisition which is relevant to this question and which may be disclosed in contemporary documents - such as bank records if you took out a loan to buy the property. Inland Revenue can gain access to such documents if it wishes to explore the background to a purchase in checking whether the profit is taxable.

Even if you bought the property other than with a resale in mind, the profit on the sale would nevertheless be subject to income tax if, at the time you acquired the property, you or an associated person carried on the business of dealing in land, a business of developing or dividing land into lots, or a business of erecting buildings.

You will be associated with any company in which you or your spouse or child under 20 years (or a trust under which any of you, your spouse or child under 20 years are beneficiaries) has, in total, a 25 per cent interest. You will also be associated with your spouse and with any child under 20 years (and any trust of which such spouse or child is a beneficiary).

And you will also be associated with any partnership in which you or anyone you are otherwise associated with (for example, your spouse) is a partner.

Even if the property was not bought with a purpose or intention of resale and the profit is not otherwise taxable, income tax may still be payable if you claimed tax depreciation on the property while the property was rented.

If depreciation was claimed, then since you have sold the property at a profit, that depreciation will have been "recovered" by the sale.

For instance, if you bought for, say, $250,000, and claimed depreciation for two years totalling $19,600 (applying the diminishing value depreciation rate of 4 per cent), then at the time of sale the tax book value of the house would have been $230,400.

Assume that in the following income year you sold the house for $300,000. As the house would have been sold for more than its tax book value of $230,400, and also for more than it cost you, all the depreciation claimed would have been recovered by the sale as the house had appreciated (not depreciated) in value.

Consequently, $19,600 would need to be included as gross income in order to reverse the depreciation deductions.

By contrast, if the house had been sold for only $240,000, then only $9600 of depreciation would have been recovered with only that amount required to be included in gross income.

Even if depreciation has been claimed, it is only to the extent that that depreciation is recovered in the sale price that a tax obligation arises.

Any "excess" gain on sale is not subject to tax simply because depreciation deductions have been claimed.

Although all depreciation may be recovered, there is still the advantage of the time value of money from having been able to claim those depreciation deductions.

Incidentally, given that New Zealand is enjoying a rising property market, the Minister of Revenue has recently wondered whether depreciation should be able to be claimed by landlords.

Technically, "depreciable property" is only property which might reasonably be expected to decline in value while used in deriving gross income, but Inland Revenue's practice is to allow depreciation on all rental property.

Depending upon your personal circumstances, the provisional tax rules may apply to any taxable gain (rather then merely accounting for the tax by terminal tax date), and therefore professional advice should be obtained.

* Send us a commercial property question

Each week the Commercial Property Group at Simpson Grierson will answer questions on commercial property issues. The information in this column is intended to provide general information in summary form current at the time of publication. The contents do not constitute legal advice and should not be relied on as such. Specialist legal advice should be sought in relation to specific issues.