If you have bought and sold a residential property in the last few years, you may be in Inland Revenue’s sights. Inland Revenue is actively following up those it considers have not paid tax on certain property transactions. On the back of significant media interest in the housing market, Inland Revenue has recently sent letters to tax agents informing them that certain clients may have entered into transactions subject to the residential bright-line test.

Taxpayers may become inadvertently caught up in these rules and the related tax obligations, in several different ways. For example, through the acquisition of property in their own name and the subsequent transfer within a short time frame of that property to a family trust.   

The letters state that these taxpayers are required to pay income tax on any profit they’ve made on the sale of bright-line residential property. The letter requires taxpayers to complete the bright-line IR833 form and pay the tax due, or if overdue, they will need to file a voluntary disclosure. Penalties and interest may apply if tax is overdue.

The bright-line test

The bright-line test for residential property was introduced in 2015 and extended in 2017. It applies to any person that sells a residential property:

  • Within two years of it being bought between 1 October 2015 and 28 March 2018 inclusive; or
  • Within five years of it being bought on or after 29 March 2018.

The test treats a gain on the sale of the property as income, with exclusions only for the sale of the main family home, or where property is sold after it’s been inherited. Taxpayers selling property within the two or five year bright-line periods are expected to consider whether the test and exclusions apply.

Until now, there has been little enforcement activity from Inland Revenue on this issue.  However, Inland Revenue’s data shows that up to 25% of taxpayers may not have disclosed and returned taxable income arising from property transactions subject to the bright-line test.  

Who is receiving the letters?

There are three likely situations (but not exhaustive) that apply to taxpayers receiving these letters:

  1. They have bought and sold property within the relevant bright-line periods but, despite Inland Revenue’s assertion, an exclusion applies (i.e. the property has been used as the taxpayer’s main home). It could also be the case that while the sale is prima facie within the relevant bright-line period, the original property purchase was entered into before the rules applied. 
  2. They may technically meet the requirements of the bright-line test, but individual circumstances could apply mitigating the position.
  3. The purchase and sale is within the relevant bright-line period, none of the exclusions apply, and the taxpayer has failed to disclose it to Inland Revenue.

What to do if you have received a letter

It is relatively straightforward to inform Inland Revenue that the bright-line test doesn’t apply where you fall under the first category of letter recipients. (Inland Revenue has publicly acknowledged that some letters were sent in error).

The second and third situations are more complicated and need to be judged on their own merits. Sometimes an explanation will exist as to why the sale is not taxable, or if taxable, a voluntary disclosure will need to be made along with submissions to remit penalties and interest (which will prima facie apply).

Taxpayers that have received one of these letters or have brought and sold property within the bright-line periods should contact their tax advisors to discuss what they need to do to comply with the bright-line test. Importantly, there is no statue of limitations on how far back in time Inland Revenue can go if profits from the sale of property are taxable under the bright-line test but have not been disclosed. 

This campaign shows Inland Revenue using its new computer system and wider access to data to respond to a high-profile “compliance” issue. We expect the use of data to monitor taxpayer compliance will rise dramatically over the next few years. We expect Inland Revenue to undertake similar campaigns on other topical issues as they arise.