By Nigel Jemson, Senior Manager, PwC.
Inland Revenue (IR) has recently released draft guidance on applying the bright-line test to transfers of residential property in close family situations.
This includes situations where parents assist their children in purchasing a residential property because the child is not able to do it without assistance or the child needs more time to access their Kiwisaver funds.
This is commonly referred to as ‘the bank of mum and dad’ and is an increasing source of lending for first home buyers, according to Consumer.
With recent property price rises, ‘the bank of mum and dad’ appears to be a growing trend, so parents should be aware of the potential tax consequences of assisting their children into property ownership.
A common scenario is where parents acquire a partial or full ownership share of a property and later transfer ownership to their children once the child repays them the original amount contributed. The draft guidance provides an example:
Blake has savings but not enough to buy a house with an asking price of $900,000. Blake’s parents obtain a mortgage for $900,000 to purchase the property under their names. Blake moves in and lives in the property and makes payments to his parents to reimburse them for their mortgage interest expenses and other expenses relating to the property.
Four years later, Blake’s parents sell the property to him for the sum of $900,000, which is the same as what they paid when they acquired it. The bank lends Blake $720,000 (80% of $900,000). Blake also pays $180,000 from his savings to his parents directly.
The market value of the property at the time of the sale from Blake’s parents to Blake has, however, risen to $1.2m.
The draft IR guidance confirms in this scenario that:
- The transfer of ownership to Blake is subject to the bright-line test;
- The tax rules deem the parents to have derived the market value ($1.2m) on the transfer of the property rather than the $900,000 paid by Blake to them.
- Consequently, the parents are taxable on the $300,000 net gain made on the property transfer to Blake under the bright-line test.
A similar outcome would apply if a parent acquired a partial stake in a property (e.g. 20%) to help a child provide a sufficient deposit to purchase a home and was listed as a part owner on the title and later transferred this ownership stake to the child.
Many will not be aware of the market value rule that deems a taxable profit to arise (and a tax bill to be paid!), even when the parents do not make a cash gain on the transfer. This may be a nasty surprise for parents entering into these arrangements who are unaware of the potential tax consequences. As the bright-line test is now ten years (for properties acquired on or after 27 March 2021), parents in this situation must wait ten years before transferring full ownership back to their children to avoid the application of the bright-line test.
If possible (and the bank will allow it), one alternative is for parents to consider providing an interest-free loan to their children to purchase residential property. This ensures that there are no future transfers of ownership that could trigger the bright-line test. Such arrangements should be documented in writing to avoid any future issues down the line (for example, if the child’s relationship breaks up).
The key take-home is when you enter into a ‘Bank of Mum and Dad’ arrangement, be aware of the potential application of the bright-line test!
Expert Advice
Do you have a burning question relating to tax, accounting, or finance you'd like answered by Nigel? Send an email to [email protected] to have your questions answered by the expert!
Thanks again to Nigel Jemson from PwC for the content of the above article. Nigel is a Senior Manager at PwC (www.pwc.co.nz), and provides a full range of accounting, tax, and business services to leading global, national, and local companies and to public institutions.
