COMMENT: Last month, the Government announced a suite of policies aimed at helping first home buyers and taking the heat out of the housing market. One of these policies was the extension of the brightline test from five to ten years, which could have an effect on how divorcing couples separate their assets.
What is the brightline test?
The brightline test is the period in which vendors are liable to pay income tax on any profit they made on the sale of a residential investment property (i.e. any house other than the family home). For properties acquired before October 1, 2015, when the rule was first introduced, the bright line rules do not apply. For properties bought between October 1, 2015 and March 28, 2018, tax was liable if the vendors sold it within two years. The rule was extended to five years for investment properties brought between March 29, 2018 and March 26, 2021, and extended to 10 years for investment properties brought on or after March 27, 2021.
How does that have anything to do with my divorce?
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At the end of a marriage, civil union or a qualifying de facto relationship, a couple must divide their relationship property according to the rules of the Property (Relationships) Act 1976. If they have a pre-nup, they can opt-out of the default rules. However generally, couples will divide their relationship property 50/50.
Real estate is usually the most significant asset to be divided at the end of a relationship. After their separation, a couple may agree that one party will buy the other party out of the property. Alternatively, they may choose to list it on the market and divide the proceeds of sale.
If the couple has multiple properties, such as the family home and a holiday home, they may agree to keep one each. This option can be complicated by the tax implications of the brightline test.
Implications on separation settlements
The new threshold will only affect investment properties bought on or after March 27, 2021. If one of the parties cannot afford to buy out their partner’s interest, then the couple may have no choice but to sell the property and divide the proceeds of sale – the profits of which will be liable for tax, as would any profits on properties bought on or after March 29, 2018 and resold within a five-year period.
The new law may force some divorcing couples to look at retaining any investment properties they have, so as not to be hit with the capital gains tax.
If the separation is amicable, the parties may consider a Property Sharing Agreement to record their joint ownership of the property until they are able to sell tax-free. It also gives them a mechanism to sell at any time and save further legal fees. This is not an ideal solution because the parties will have financial interests after separation; however it may be the reality for those who own high value or multiple properties.
Tax consequences
The tax consequences of retaining a residential investment property should be factored into settlement negotiations. Not only do investors need to factor in the new brightline test but also the loss of being able to claim the cost of interest as a tax deductible expense, either immediately for purchases on or after March 27, 2021 or in the future for past purchases.
Once a settlement has been reached, each party is responsible for their own tax obligations. The party who retains an investment property may be unfairly burdened with the tax implications of the above changes as opposed to the party who retains the family home and can sell that property at any time without incurring tax because family homes are exempt from the brightline test.
It can be agreed that the couple will divide any tax that the party incurs but this must clearly set out in any settlement agreement.
Increased cost of settlement
When a capital gains tax is contemplated, a valuation of the property will need to be obtained. This further adds to the cost of finalising a property settlement in both time and money.
The extension of the brightline test and the change in the taxation of interest costs create a tension between the clean break principle under the Property (Relationships) Agreement 1976. It may cause more couples to enter into property sharing agreements and have longer periods of entanglement with their ex-partner.
- Jeremy Sutton is a senior family lawyer, specialising in divorce cases where there are significant assets, including family trusts and complex business structures
