Property brightline test returns to two years
AFTER months of announcements and working through coalition agreements, legislation has finally been released to bring into effect the highly anticipated property tax changes.
Headlining the changes is the reduction of the brightline rule back to a twoyear time period and the restoration of interest deductibility for residential landlords.
The brightline rule was originally introduced in 2015 to target property speculators, whereby the sale of residential property sold within two years would be subject to tax, unless an exemption applied, such as a person’s main home.
Over time this brightline period has been extended twice, firstly to a fiveyear test in 2018 and then to a 10year test in 2021 (although new builds would qualify for a fiveyear brightline period).
The rules also became increasingly complex as tweaks were made to try to attend to unfair outcomes. Perhaps the biggest of these were innocent homeowners getting caught because the main home exemption wasn’t great at dealing with real world realities, such as a genuine change of circumstance.
The change back to a twoyear test will have a retrospective effect, as it will apply to any residential property disposed on or after July 1, 2024, irrespective of when the property was acquired. Property sold before this date will continue to apply an existing brightline rule.
One thing to note is that for brightline purposes disposal will typically be the date a person enters into an agreement, not the date of settlement. Therefore, care is required in determining which rule applies. For example, if a contract for sale was entered into on June 20, 2024 which settles on, say, July 20, 2024, it will subject to the existing brightline rules, not the new twoyear test, because its disposal event occurred before July 1.
The changes will also see a reversion in the main home test back to its simplistic original form from April 1, 2024. Currently the main home test is more of apportionment-based approach which can be complex (but arguably fairer), while the original rule was based on whether a property was predominantly used for most of the time it was owned as a main home.
The down side of simplicity is that this could result in some unfair outcomes at times, although with a twoyear time period this issue is easier to manage when the brightline period is only two years, as opposed to 10 years.
Thankfully, one recent addition to the rules has been retained. The time taken to construct a property shouldn’t count towards a period of ownership when assessing whether the main home exemption applies. This has provided welcome relief for those building a house during which the property couldn’t be used as their main home.
One surprise in the legislation is the expansion of the rollover rules. One of the longstanding issues with the brightline rules is that they still applied if a person transferred ownership to their associated entity, such as to a trust. The rollover rules were introduced in 2022 to attend to this to allow some associated transfers to occur without triggering brightline outcomes. But they were limited in application and relatively complex.
The changes will now extend the rollover relief to any “associated persons” transfer. However, the associated persons must have been associated for at least two years before the date of transfer. The relief can also not be applied more than once in a twoyear period.
This is a welcome change as the original intent of the rules was focused on property speculators, not transfers of property between associated persons, although it is important to clarify exactly who is an associate under the tax rules before actioning any such transfer. These changes will also be in effect for transfers from April 1, 2024.
It could well be the case that there are transactions haven’t been undertaken due to restrictions in this area.
The other key change announced were the changes to interest deductibility on residential property.
These changes were introduced in 2021 by the then Labourled government to reduce the benefits received by landlords. The upshot was that most landlords were denied an interest deduction to claim against their rental income. Some properties were exempt, but most rental stock was affected. For some, the rules resulted in no interest deductions from October 1, 2021, while others were having their interest deductions phased out over five years.
It was originally agreed between the coalition parties that interest deductibility would be phased back in over three tax years, beginning with the current 2024 tax year, whereby 60% of interest would be claimable. However, due to complications and the government books, the changes instead will be delayed.
Instead, they will be reinstated over two years beginning from April 1, 2024 where property owners will be entitled to claim 80% of their interest cost against their rental income. This change will also extend to many who currently claim any interest deduction, not just those subject to the phaseout. For instance, those who purchased their property after March 27, 2021 were generally denied an ability to claim interest. Those currently able to claim 100% of their interest, will remain able to do so.
From April 1, 2025, there will be 100% reinstatement, allowing all property owners to all of their interest.
One aspect to note with these rules is that this is unlikely to result in large tax refunds for landlords. This is because they are still limited in their ability to offset their rental deductions against other income because the loss ringfencing rules remain in force.
A final change that was a policy of both major political parties is the removal of depreciation on buildings from April 1, 2024. Affected owners should review their position and also assess if their fitout portion of a building has been adequately determined.