Tax And Your Property Transactions - IRD

Tax and your property transactionsClaiming a loss from propertydealing or speculationWorking out if you can claim a loss from aproperty transaction is similar to working out ifa profit is income or not.If you're a speculator and buy property withthe firm intention of selling it, but then make aloss on it, the loss is likely to be tax deductible.You'll need to take into account other generalrules covering the deductibility of expenses orlosses. You can only claim the loss on a propertywhen you sell it.If you're a dealer, the loss is also likely to bedeductible, provided you buy the property forthe dealing activity.Some people, who didn't see themselves asproperty dealers or speculators when theymade profits from their property transactions,may take a different view when they makelosses.However, we don't just look at a one-offtransaction when considering losses claimed.We review all your past property transactionsto see how the profits or losses were treated fortax purposes.If you're considering claiming a loss on aproperty transaction, we strongly recommendyou talk to a tax professional.ird.govt.nz9

ird.govt.nzTax and your property transactions10When rental property investmentbecomes rental property dealingOwning rental property doesn't automaticallyexclude you from paying tax when you sell it.Depending on the reason you bought theproperty or on other factors, like carrying ona property-related business, you may be aspeculator or dealer.When housing prices are on the rise, "get richquick" property schemes are often describedas property investment, when they're reallyproperty dealing or speculating schemes.Some property schemes are described asproducing capital gains, which aren't taxable,rather than producing income, which is. Youneed to consider several factors to work outif profit from property sales is capital gains orincome:your intentions when you bought thepropertywhat you actually used the property forif you have a regular pattern of buying andselling propertywho you're associated with.If you change from investor to dealer your taxsituation changes too. Properties bought beforethis change may not be affected.Different outcomesAn investor buys a rental property to generaterental income.A dealer or speculator buys a rental propertywith a firm intention to make a gain from theincrease in its value.A dealer is anyone with a regular pattern ofbuying and selling properties. This includesrental properties.To be a speculator, you need buy only oneproperty, firmly intending to resell it.Investors pay income tax on their net rentalincome but generally, not on the eventual saleproceeds of the property.Dealers and speculators must pay income taxon any gain they make from reselling theirproperty. If they have a loss, it may be taxdeductible. They must also pay tax on thenet rental income they may earn from theproperties.If you're counting on the rental of yourproperty to provide a positive return on yourinvestment (even if expenses may at first begreater than the rent you get), you're likely to bean investor. But, if you buy a property intendingto resell it, or if you intend to sell it aftermaking improvements to it, you're likely to be aspeculator. Renting your property temporarilydoesn't change your tax treatment either –you're still a dealer.

ird.govt.nzTax and your property transactionsStill can't decide?Ask yourself, "Is the property going to give mea return on my investment, or will it only giveme a positive return when I sell it at a profit?".You may receive some income from renting theproperty but if, from the outset your real reasonfor buying the property was to sell it at a profit,you're a speculator.11Once you're a dealer (or associated with one),special rules apply. Any profit may be taxable ifyou own any properties whether or not for thepurpose of dealing, and:sell any property that is part of the assets ofthe activity of dealing, orsell any other property within 10 years ofbuying it.Some investors may find the returns frombuying and selling rental properties are muchhigher than the actual rental income thoseproperties can provide, so they switch frombeing investors to dealers.This applies to all properties you buy from thetime you begin dealing to the time you ceasedealing, and includes rental properties.If you start dealing in rental properties, anyprofits on your sales from the time you becomea dealer are taxable.Rental properties don't qualify as a business forthis exclusion.This probably won't affect the sale of any rentalproperties you owned before becoming adealer, assuming you bought them to providerental income, not for resale.DepreciationSpecial rules for dealers andbuildersProperties sold as part of a property dealing orbuilding business are taxable in the same waytrading stock of a business is.Property dealers and builders (and thoseassociated with them), should also take extracare when dealing with properties that weren'tbought as part of their business activities ifthose properties are sold within 10 years.There are exceptions for some privateresidences and business premises.Changing from rental property investment torental property speculation or dealing can alsoaffect depreciation on your properties. Rentalinvestors can claim annual depreciation on thecost price of their property buildings, fitout andfurniture, but investors who hold property astrading stock can't claim annual depreciation –see page 21.NoteFrom the 2012 income year you can nolonger claim depreciation on rental propertybuildings.NoteFrom the 2021 income year depreciationon non-residential buildings has beenreintroduced. Refer to our guideDepreciation - IR260.

Tax and your property transactionsSwitching back to propertyinvestment from speculationor dealingProperties you bought as a dealer, builder ordeveloper are treated like trading stock and aretaxable when you sell them, regardless of anychange in your status.For example, if you buy a rental property whenyou're a dealer but decide to hold it and rent itduring a market downturn, any later gain on thesale will still be taxable, even if you're no longera dealer.If you intended to resell your rental propertywhen you bought it, talk to a tax professional.You may have to file an Individual tax return- IR3.ird.govt.nz12

Tax and your property transactionsUnplanned rental incomeAs a speculator or dealer, you may decide thetime isn't right to sell a property, so you rent itout instead. If you do this, there are implicationsfor income tax, and GST (if you're registered).Income taxYou'll have to include rental income in yourincome tax return. You may claim costs orexpenses associated with the rental. Newresidential property deduction rules apply tomost residential rental properties from the startof the 2019-20 income year, which for mostpeople ends on 31 March 2020. See our Rentalincome - IR264 guide for more detail.GSTGST-registered speculators or dealers, whoclaim a GST refund on the property whenthey buy it and then rent the property to aresidential tenant, need to make an adjustmentin their GST return to reflect this.If you buy a property for the principal purposeof making taxable supplies (in this case,property dealing/speculation, or commercialrents), but then use it for another purposeother than making taxable supplies (eg,residential rental), you must make a GSTadjustment.For details about making adjustments, seepage 18 of our GST guide - IR375.We advise you to talk to a tax professionalbefore renting out your property if it's a partof your normal dealing, especially if you're afirst-time renter.ird.govt.nz13

ird.govt.nzTax and your property transactions14Special tax rules for those inproperty-related activitiesSpecial tax rules may apply to you if you ownproperty and you or an associate are involvedin dealing in land, building and constructionwork, or in subdividing or developing land.For example, the amount of time you'veowned your property becomes an importantconsideration for tax purposes.Any profit from a sale maybe taxable if youor an associated person undertake any of theabove activities and:sell any property that is part of the assets ofthe activity of dealing, building etc, orsell any other property within 10 yearsof buying it or (for builders) completingimprovements to it, that was not used inyour business.These rules may apply to any properties boughtduring the period of your property-relatedbusiness activities, even if you sell a propertyafter you cease these business activities.There are exceptions to these special rules, eg,where the property you sell was used primarilyas your family/private home, or if you used itas your business premises, other than for rentalactivities.ExampleTrent started buying and selling residentialhouses in 2008. By the end of 2008, he hadestablished a regular pattern of buying andselling and was a dealer for tax purposes.Trent co-owns Trent Rentals Ltd, a companythat buys residential rental investmentproperties. In January 2010 the company buys arental property to hold and rent. In December2014, rentals in the area are falling and it sellsthat property. Income tax would not normallybe due on the profits from the sale, becausethe company bought it as an investment. But,because Trent Rentals Ltd is associated withTrent, who established himself as a dealerbefore this property was bought and it was soldwithin 10 years, Trent Rentals Ltd must pay taxon the sale regardless of the company's originalintention to hold it as a rental investment.To understand the special tax rules thatapply when you or an associate are dealingin property related activities, we stronglyrecommend you talk to a tax professional. Youshould get advice before selling any propertyyou have held for less than 10 years, if it isn'tpart of your or your associate's business.

ird.govt.nzTax and your property transactions15Property transactionsand associated person rulesIf you have an association with people incertain property-related industries, there maybe a tax impact on all or some of your propertytransactions, even if you're not personally aproperty dealer, developer or builder.These impacts could mean the difference in thegain from the sale of a property being treated astaxable income or as a non-taxable capital gain.The example on page 16 shows how theassociated person rules could affect you whenyou wouldn't have even considered such anassociation. So, if you're considering investingin property or selling your private residence,it's important you talk to a tax professional.Particularly if you think there is any possibilityof an association applying to you.How individuals can beassociatedThere are a number of tests used to workout if two persons are associated for landtransactions.Under the basic rules you are, for example,associated with:your spouse, civil union or de facto partneryour children (under 20 years old)a company you hold 25% or more marketinterest in (company and individual test)a company your spouse or children hold25% or more market interest in (theaggregation rule)a company where the combined holdingsunder all these rules totals 25% or moremarket interest in (the aggregation rule)a partnership, if you're a partner.Associated person rules may make a propertysale taxable when there's an association with:a property dealer when the property wasboughta property developer when the propertywas boughta builder when significant improvementsstarted on a property.NoteAssociated person rules changed for landacquired on or after 6 October 2009,widening some associations.If you're a trustee you're associated with:any settlor of the trust (and vice versa)a trustee of another trust where the trustshave a common settlora person with power to appoint or removea trustee.

Tax and your property transactionsExtended associationsYou can be associated to a third person, whereyou're already associated to a second personunder the above rules, and that second personis associated to the same third person under adifferent rule from the rule that associates youto the second person.This is called the "tripartite" test and usuallymeans that if person A is associated withperson B, and B with C, person A is alsoassociated with person C. There are exceptions,particularly in relation to the company tests,so it's important to talk to a tax professional ifyou're in doubt.ExampleKim is married to Bruce, a property developer.Kim is settlor and trustee of a trust, which ownsall the shares in Kim's family company.So, Bruce is associated to Kim under the tworelatives test. Kim is associated to Kim's trustunder the trustee and settlor test.Bruce is now also associated to Kim's trustbecause of his association to Kim as spouse andKim's association to the trust as settlor.Bruce is considered to hold what Kim's trustholds, which is 25% or more of Kim's company.So, Bruce is associated to Kim's company.ird.govt.nz16Any land transactions Kim's company makeswould be treated as if it were being made by aproperty developer (Bruce's occupation).For more information on the associated personsrules read Tax Information Bulletin Part II,Vol 21, No 8 (October/November 2009).You should talk to a tax professional if youthink any of the association rules may affectyou.

Tax and your property transactionsird.govt.nz17Living in a property owned by yourLTC, company, partnership or trustSome people buy or transfer a family homeusing a limited liability company, such asa look-through company (LTC) or trust orpartnership, including a limited partnership.This guide focuses on LTCs but the informationapplies equally to trusts or partnerships.The new residential property deduction rulesapply whether you hold the property yourself,or in a partnership, look-through company, orclose company. The rules also apply to trusteesof a trust who earn taxable income from aresidential rental property.Using an LTC for residential rental investmentcan be a perfectly valid structure. However, weconsider some LTC arrangements are made toavoid tax.Now, you can generally only deduct expensesfor residential property up to the amount ofincome you earn from the property for theyear. Any deductions over your income fromthe property are called excess deductions, mustbe carried forward to the next income yearyou earn income from the property (or otherresidential property).Problems arise when an LTC buys an LTCshareholder's family home, and shareholderscontinue to live in the home and claimdeductions (eg, interest, insurance, ratesand maintenance) for the property. In mostinstances this is considered tax avoidance.Expenses in relation to your private residence,whether owned by you, a company in whichyou're a shareholder, a trust in which you're abeneficiary or a partnership you're a partner in,are not deductible.You may think that if you continue to paymarket rent to the company you can continueto claim these LTC expenses against yourincome. However, we may still consider thearrangement to be tax avoidance.Penalties might applyTax avoidance carries penalties of up to 100%of the tax shortfall, and in some cases, suchas deliberately misleading Inland Revenueabout how the arrangement is set up, there'sa shortfall penalty of 150% for tax evasion.We may also consider prosecution.This means that rental property losses cannotbe used to reduce your tax liability for otherincome, such as salary and wages or businessincome.

ird.govt.nzTax and your property transactionsLiving temporarily in aproperty owned by your LTCFrom time to time a shareholder will moveinto a home owned by their LTC which theypreviously rented to tenants. There may begood reasons why they do this. For example:inability to find tenantsrelationship breakdownrelationships formed with tenantsrenovating or building your own home.But, if you live in the property and you'rea shareholder, you generally can't continueto claim what would otherwise be privateexpenses.Whether or not this structuring and claimingof resulting losses is considered tax avoidancedepends on a number of factors. For example,whether the arrangement is permanent ortemporary, and whether there are commercialfactors driving the decision to live in theproperty.Living with your tenants in aproperty owned by your LTCThe situation around tax avoidance is lessclear when both a shareholder/owner andother tenants live in an LTC-owned home. Theshareholder/owner's proportion of the expensesis generally not considered deductible. We lookat these arrangements on a case-by-case basis.18Asset protectionSome people claim the main reason for holdingtheir personal residence in a limited liabilitycompany is for asset protection rather than tominimise tax.In reality, these structures provide little or noasset protection. For shareholders to makeuse of LTC losses, they must hold the sharesin their own name. The market value of theshares of an LTC company that owns residentialinvestment property is equal to the marketvalue of the property and represents an asset tothe shareholder, less the mortgage. A creditorclaim equal to the current value of the propertyis possible.We look closely at the reasons for sucharrangements, but usually disregard the assetprotection argument when considering if anLTC arrangement is tax avoidance.If you're considering setting up an LTC to ownyour family/private home for tax loss claimpurposes, be aware that we consider thesetypes of arrangements to be tax avoidance.If you're moving into your LTC-owned propertyover the long-term, consider taking the homeout of your LTC.If you're moving into an LTC-owned propertyon a temporary basis, be careful not to claim adeduction for private expenses for the periodyou're in the home.We strongly recommend you talk to a taxprofessional with expertise in this area if you'reconsidering any of the above arrangements.

ird.govt.nzTax and your property transactions19GST on apartment purchasesand salesWhy do people register for GST when they buyproperty, particularly apartments?If an apartment is being used for short-termstay accommodation (ie, less than four weeks)the rental income may be taxable supplies forGST purposes.Many apartments are sold as "going concerns"with management leases and guaranteed rentalarrangements in place at the time of purchase.No GST is paid or can be claimed on aproperty sold as a going concern, providedcertain conditions are met, ie, both parties areGST-registered and the management leasesand rental arrangements remain in place. Thetransaction is defined as "zero-rated" for GST.However, the future sale will be subject to GSTu

9 Claiming a loss from property dealing or speculation 10 When rental property investment becomes rental property dealing 13 Unplanned rental income 14 Special tax rules for those in property-related activities 15 Property transactions and associated person rules 17 Living in a property