Inland Revenue will advise a change to tax law after the introduction of the bright-line test had an unintended consequence for parents helping their children into home-ownership.
Deloitte tax partner Robyn Walker and tax director Susan Wynne recently outlined how bright-line rules may throw up surprise tax liabilities for parents entering into co-ownership arrangements when helping their children with homeownership.
The bright-line test taxes income arising from the sale of a residential property when a property was sold within a certain time frame.
As the law stands implications arise if parents co-own a home with a child and the ownership structure changes, for example from 50:50 ownership to 75:25, because the legal title of the property has changed.
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This could result in a tax liability and restarting the bright-line test period at 10 years again.
Furthermore, if the property is sold or gifted at an amount below its market value within the bright-line period (for example a child is repaying their parents), then the transaction is recorded at the market value of the property at the time of disposal.
If the market value of the house had increased from $500,000 to $1 million then parents would be taxed on whatever their share of the $1m was rather than the income they had received as a repayment for their share.
An IRD spokeswoman said when a part share in a property was disposed of, that share could be subject to tax under the bright-line test.
Where there was a change in proportions of ownership, as currently drafted, the rules would result in the bright-line clock resetting for both parties, the spokeswoman said.
“This resetting of the clock is not the policy intent, and we intend to advise that the legislation be amended to clarify this.”
“The policy intent is that the clock should reset only for the newly acquired share.”
For example, if the ownership went from 50:50 to 25:75, the intention is that the clock should reset only for the 25 per cent share transferred.
Walker said the law change should be retrospective, at least back to March 27 when the bright line test was extended from five to 10 years.
“That would be probably a fair thing to do,” Walker said.
She said it was good that an amendment would be recommended so that the bright line would be reset on just the proportion of the property that transferred ownership rather than on the whole property.
But it was not doing anything to solve the issue of parents still having to pay tax on the proportion of the property they transferred, which was calculated at the market value of the proportion, she said.
“They’re still going to be taxed on that gain that they made,” Walker said.
And it still reset the proportion of property that had been transferred.
“It’s starting to make progress, but it’s not a solution to the full problem which still exists.”
Parents would need to be aware that tax liabilities would still arise from helping their children buy property, she said.
If parents wanted to avoid a tax liability they should wait 10 years before they did anything with the ownership structure of a home, she said.
“Maybe that’s realistic. It will probably take people 10 years to get into a position where they could even buy out mum and dad.”
It might end up being a non-issue, but it might not, for example if they needed to move city and sell the property, she said.
“That will still create that taxing event for the parent.”