Q. My partner and I are separating after living together for seven years and we are in the process of dividing our assets. We own our home which we purchased in 2013 and a small investment property which we purchased in June 2018 for $750k. My partner wants me to take the smaller investment property which is valued at about $800k, and he will take our current home. I’m worried about tax though. With the new rules, will I have to pay tax on the property when it is transferred to me? Also, my partner wants our accountant to calculate the income tax we owe before we divide our property. It seems like a waste of money since we will each need to do this again in six months at the end of the financial year. Is this what most people do when they separate?
A. Accepting a rental property as part of your settlement
You’re talking about the bright-line test – a tax on the profits (or capital gains) from a property sale. The tax applies only to residential property and property which is not your main home; for example, a bach or rental property.
In October 2015 when the test was first brought in, it applied to property sold within two years of purchase. Later the time period was extended from two to five years.
It doesn’t matter whether your intention was to hold the property forever, rather than make a profit – tax is still payable if you sell.
How does this apply to your relationship property settlement?
When a relationship ends, property can be transferred between partners as part of the settlement process, just as you want to do here. This transfer is not treated as a sale, so there is no tax liability under the bright-line test at this point.
However, if you go on to sell the property before June 2023 (five years from the original purchase date), you will have to pay tax on the profits of the sale. For example, if you sold it next year for $850k, you would be deemed to have made a profit of $100k and would have to pay tax on this amount. Once you have finalised your split of relationship property, this tax would be your sole responsibility.
There is an exemption to this rule where the property has been used predominantly as a person’s main home during the time of ownership. If this exemption applies to you, then you would be exempt from paying tax under the bright-line test.
So, if you decided to live in the property for say the next three years and then sold it, you would be exempt from paying tax. However, none of us can be certain of where we will want to live years from now.
While you and your partner may have divided your property equally from a monetary standpoint, you have less flexibility in what you do with your share. The property your partner is taking has always been the family home, so is not subject to the bright-line test at all. If he decides to move overseas or can’t afford the mortgage, he is free to sell up at any time and enjoy all the profits from the sale. If you did the same, you would be looking at a big tax bill.
This is something you should consider when you are negotiating the settlement – what is the likelihood that you might want or need to sell this property, and can you be compensated in some way for the risk of having to pay tax?
Calculating your tax obligations
If there is not a prenup agreement in place, a couple’s income during their relationship is shared, along with any associated tax debts which are relationship debts. Once their relationship property agreement has been signed, each person is responsible for their own tax obligations.
If you are in a salaried role, your income tax (PAYE) is generally deducted as you earn it. Therefore, you’re not likely to receive a substantial tax refund or have a large amount of tax to pay at the end of the tax year.
If income relates to a business, only some of the tax is paid on a regular basis. There may still be a significant amount of tax to pay at the end of the tax year. If this isn’t accounted for in a settlement, an unfair situation could arise where one of the parties has contributed their income to the relationship, but ends up solely responsible for the tax which isn’t calculated and paid until months later, after their relationship property agreement has been signed.
If couples think tax could have a big impact, they often seek advice from their accountant when preparing their relationship property settlements.
If you are having property transferred to you in a settlement, you need to consider whether the bright-line test could affect you. If you sell within the bright-line time frame, you could end up paying a lot of tax so you should factor this into negotiations with your partner.
It is also important to consider any other taxes which might be payable after your settlement has been finalised. If your tax obligations have been calculated and accounted for in your separation, you can both move forward knowing that your split is fair and there won’t be any unexpected tax bills relating to the time you were together.
This article was first published in NZ Herald.