February 16 2008
Many of you may have seen the ‘Property Climbers’ programme on television which must greatly amuse the Inland Revenue Department. This article looks at the tax implications for people who regularly buy and sell property.
Most people do not fully appreciate the tax implications of property transactions. The Inland Revenue Department (IRD) has dedicated task forces that are solely dedicated to investigating property transactions. The IRD focuses on anyone buying and selling property, not just developers who do it for a living.
There are many misconceptions about the tax obligations on the sale of property. Sections CB 5-13 of the Income Tax Act 2004 (the Act) set out the rules.
Any property purchased with the intention of resale will result in tax being payable on any profit. The intention of resale does not have to be the dominant intention – merely an intention to sell, amongst other intentions, suffices to capture the income as taxable. It also does not matter how long the property was owned or what its use was prior to sale.
When the IRD audits property transactions, it obtains information from a number of sources including lenders and consent applications at councils. These organisations are legally obliged to disclose their files to the IRD. The IRD looks for such things as file notes made by bank personnel which may indicate the purchaser’s intention when they applied for finance. Any mention of a possible resale to a lender may seal your fate. Of course most people intend selling their family home at some stage; just don’t tell your bank.
There are exemptions for the sale of your personal residence, but the exemption is negated if there is a regular pattern of acquiring and disposing of, or erecting and disposing of dwellings. This can capture ‘property climbers’ buying a house, living in it, renovating and then selling. There is no magic number of transactions that are acceptable to the IRD. Once a regular pattern is established, profits are taxable. Under the complex associated person rules, all family members will also be captured as property dealers, and they may become accidental taxpayers.
Builders are subject to a special set of rules. In this context ‘builder’ means anyone in the business of erecting buildings. Building company employees would generally be exempt, unless they are caught by the associated person rules. Taxable income can arise where a builder, or someone associated with a builder, acquires property, including their personal residence, and irrespective of the intention when acquired, then makes improvements to the property. If the property is sold within 10 years of making those improvements, any profit will be taxable. The improvements must of more than a ‘minor nature’ which is very subjective.
Subdivision of land around a family home can also be a taxable activity. There is an exemption available, but much depends on the number of lots in the subdivision and the extent of the work necessary to achieve the subdivision. The creation of any more than two lots would most likely be captured as a land development business. It should be noted that the exemption is not available to land owned by a trust.
The above outlines are simplistic, but the rules are not. We strongly recommend that you consult us if you are contemplating subdividing, buying or selling property, not when the deal is done.