Here’s why the bright line test change has pros & cons

Sunday, 24 March 2024

EXPLAINER: The Government is delivering on another of its promises to property investors by cutting back what passes for a capital gains tax in New Zealand.

Under the bright line test, sellers have to pay taxes on the profits from the resale of properties that are not classified as their main home, and are sold within a certain time frame. For existing properties, it is 10 years, and for new builds it is five years.

It is the closest New Zealand has to a capital gains tax.

Unlike most comparable countries, New Zealand does not have a comprehensive capital gains tax, despite a series of tax reviews and inquiries that have recommended one over the years.

In a report released on Wednesday, the International Monetary Fund once again called for the country to introduce one, as well as a land tax.

But instead tax legislation which will cut the bright line test period to two years from July 1 is currently making its way through parliament.

So why is it an issue?

What is the bright line test meant to do anyway?

The bright line test was originally introduced by the National Government in 2015 at a time house prices were rising strongly and the practice of “flipping” was attracting attention.

It was intended to tax the capital gains made on investment properties resold within two years.

The Labour Government extended the test to require properties to be held first for five years, and then (in 2021) for 10 years.

Its second extension was at the height of the Covid lockdown boom, and then Finance Minister Grant Robertson said it was to “dampen speculative demand and tilt the balance towards first home buyers”.

Sounds worthy, so why is it changing?

Investors have always been staunchly opposed to the bright line test, with the Property Investors Federation often saying it would do nothing to reduce speculation.

In 2021, the Real Estate Institute’s Wendy Alexander said it would not increase the supply of houses as investors would hold them longer to avoid paying the tax.

During last year’s election, National and ACT campaigned on returning the bright line test to two years, and ACT said it would get rid of the test entirely.

On announcing the legislation last week, Finance Minister Nicola Willis said it honoured the Government’s commitments to reduce the bright-line test, and reinstate interest deductibility.

“These measures will put downwards pressure on rents by reducing landlord costs and encouraging residential property investment.”

But Chartered Accountants Australia and New Zealand tax leader John Cuthbertson said the change as proposed would significantly simplify the rules, and put the test more in line with its original policy intent to capture “flippers”.

The rules and exemptions had become too complex, and were capturing people who the test should not apply to, such as people building homes or away from their homes for extended periods, he said.

How many investors will be affected by the change?

CoreLogic head of research Nick Goodall said if the bright line period shifted to two years then the period of analysis would be any purchase of an investment property between July 2019 and July 2022.

That was to say that anyone who bought between those two periods would see a shortening of their bright line period by at least three months, he said.

“The number of properties purchased by multiple property owners over that period and still held by those buyers is 96,000. So, potentially 96,000 purchasers stand to benefit from the shortening of the test. “

But a comparison to today’s values also came into the equation, he said.

“For 65,000 of those properties the estimated value today is at least $10,000 more than the purchase price, so that is a more accurate number of those who could benefit, due to now not having to pay a tax on that $10,000 plus profit.”

That did not take into account any other costs, or improvements which would make the calculation more complex.

And what does that mean?

In the near term, it meant up to 65,000 investors would not have to pay tax on any profit made if they sold their property, and that could save them significant sums of money.

Cuthbertson said it remained to be seen what the economic impact would be, and whether compliance and administrative costs would be reduced.

But tax expert Terry Baucher said the reduction of the test was based around the “heroic assumption that we can put off a capital gains or wealth tax of some type forever”.

New Zealand was out of step internationally in that it has no real capital gains tax, no death duty, and no gift duty, he said. “It’s an unusual set of circumstances where wealth is not taxed.”

A recent IMF report concluded that some form of wealth tax was necessary in economies to address the problem of intergenerational accumulation of wealth and inequality, he said.

“And in this bill’s regulatory impact statement on the bright line test, Treasury and Inland Revenue made comments on the prospect of a capital gains tax to address funding and fairness issues in the tax system.”

Will it impact on the housing market?

CoreLogic chief property economist Kelvin Davidson said potential sellers would be whittled down by a range of factors.

There would be people who bought with large deposits and were cash flow positive, and others who just did not want to sell, for example, he said.

“Also, if people decide to put properties up for sale they wouldn’t all hit the market at once.

“But if you assumed a drip-feed over the course of a year, a very rough estimate might be that total listings would be 10% higher at any point in time than they otherwise might have been.”

Even if all those people actually did come forward to sell, there would likely be a dampening of price pressures, which might see them pull back again and de-list, he said.

“A shorter bright line might also bring forward some purchasing, to mop up some of that new stock, but the overall message would support the case for the ‘underwhelming upturn’ this year.”