By Vicki Ammundsen & Stephen Tomlinson
A warning to anyone thinking of transferring residential property out of a family trust: you could be caught by the bright-line test.
The test, applying to the disposal of residential land within 10 years or, in some cases, five years from the date it is acquired, applies to transfers of residential land to and from family trusts, along with the resettlement of residential land from one trust to another.
So, if ownership of a property changes within the relevant bright-line period, the clock is effectively reset. And any increase in value, whether or not a profit has been realised, is likely to trigger a tax liability, with the transferor liable for tax on the profit at their marginal income tax rate.
Review of trust arrangements
For several reasons, clients are currently reviewing trust arrangements. Obligations imposed on trustees under the Trusts Act 2019 have resulted in some clients wondering whether using trusts to hold assets still makes sense for them.
Some clients are also considering transferring income-earning assets, including residential rental property, out of trusts to minimise exposure to the new domestic trust disclosure rules.
Bright-line test
The 10-year bright-line period applies where residential land was acquired on or after 27 March 2021, unless it is ‘new build land’. The five-year bright-line period applies where residential land was acquired on or after 29 March 2018, but before 27 March 2021, and also to ‘new build land’. Exclusions apply to the disposal of the main home, transfers pursuant to a contracting out agreement and the disposal of inherited property.
Tax liability
Where residential land is transferred from a trust to a beneficiary or is resettled from one trust to another, a tax liability may arise even where no money changes hands.
If the bright-line test applies, then residential land is deemed to have been disposed of at market value. Even if the bright-line test does not apply to the disposal of the land by the trust, the new owner will still be subject to the 10-year bright-line test (or the five-year brightline test if the property is ‘new build land’) when they subsequently dispose of the residential land.
Rollover relief
Until recently, rollover relief from the bright-line test applied in only a narrow set of circumstances.
Rollover relief means the transferor is deemed to have disposed of the residential land at cost (rather than market value) and the transferee is deemed to have acquired the residential land on the date that the transferor acquired the land. Effectively, the transfer is ignored for income tax purposes.
The main circumstance in which rollover relief used to apply was where residential land is transferred pursuant to a contracting out agreement. Tax avoidance issues may arise where persons use a contracting out agreement as a device to transfer assets in or out of trusts. The Taxation (Annual Rates for 2021–22, GST, and Remedial Matters) Act 2022 extends rollover relief from the bright-line test to certain transfers of residential land on or after 1 April 2022 to and from family trusts. Full rollover relief applies only if the residential land is transferred at no more than cost.
While the extension of rollover relief to transfers of residential land to and from family trusts is welcomed, the reforms do not go far enough. Essentially, there are two problems.
First, where residential land is transferred from a trust, rollover relief applies only where the residential land is transferred to a ‘principal settlor’ who previously transferred the land to the trust. This means that rollover relief will not apply where the principal settlor made cash settlements on the trust or provided a guarantee to put the trust in a position so it could acquire the land.
Second, rollover relief does not apply to trust resettlements, despite officials previously indicating that it should. This appears to be an oversight, and Inland Revenue’s commentary on the new legislation states that this will be fixed in the next available tax bill.
More reform likely
It appears that Inland Revenue will revisit the application of rollover relief to trust resettlements in the near future. It is not clear, however, whether rollover relief will also be extended to all transfers from a trust to a ‘principal settlor’.
In the meantime, lawyers and accountants need to appreciate that rollover relief from the bright-line test for transfers of residential land to and from trusts is still limited.
Vicki Ammundsen is the director of Vicki Ammundsen Trust Law and Stephen Tomlinson is the principal of Tomlinson Law. Both are members of the ADLS Trust Law Committee. This article originally appeared in LawNews (ADLS) and is here with permission.
13 Comments
I agree.
The reality is that the issue for many is that they don’t see a trust as being a seperate entity . . . they perceive the property within a trust as still being “their property” and the trust is simply just a convenience for a number of reasons.
Placing property in a trust is transferring the ownership to another entity . . . and transferring it from a trust to individual is also transferring ownership.
I find it harder to see reason that it shouldn’t be subject to the brightline test rather than it should be.
Trusts have lost many of their advantages as they are now “seen through” in matrimonial and aged care cost issues and the ongoing costs and increased requirements mean trusts no longer justify the costs and efforts.
"Trusts have lost many of their advantages as they are now “seen through” in matrimonial and aged care cost issues and the ongoing costs and increased requirements mean trusts no longer justify the costs and efforts.'
In some case yes however not always. An example when it comes to aged cost issues.. trusts can still help maintain the capital base and mitigate loss of capital if you have an advisor who knows what they are doing and experienced in this area as a professional trustee.
To be honest not too many meet this critera so often people muddle on themselves or get bad advice...
Speckles
i agree with the comments you make.
In instances where trusts are “seen through” it is often for the reason that the property involved and the trust is seen by the settlor as theirs . .and the operation of the trust and meeting trust obligations are managed as such.
I agree that a professional trustee(s) is essential to protect the validity of a trust as a separate entity. However, due to the perception that “the property is seen as mine” means that there Is in some instances there a reluctance to forgo control.
Professional trustee(s) is essential to protect the validity of a trust as a separate entity.
Pure fiction. A narrative promoted by the Legal industry.
It is essential when forming a trust to educate yourself fully as to what you are getting into. Most people don't have a clue.
Far better not to have a professional trustee, just pay for advice (which a professional will charged for regardless of being a trustee or not) as needed.
You are totally missing the point rastus. The point of having an independent professional as a trustee is not so that "they know best for the Trust" and other trustees can absolve themselves from knowing what's best for the Trust, the point is to validate the independence of the Trust.
While professional oversight is recommended as a necessity in setting up a trust, I consider it is also strongly advisable that professional involvement continues.
A situation I am aware of (not personally connected or involved) is where a trust was professionally set up, but subsequently with the settlor treating the operation of the trust and its assets (property and and money) as their own.
The settlor did not complete annual statements (these were not previously legally required but information could be asked for by IRD or MSD) or providing evidence that other trustees were consulted, involved or informed. The settlor would acted independently (e.g. no trust minutes) regarding use or application of the trust's property and monies.
An application was made to MSD for aged-care which was rejected by MSD as the trust was considered as not being operated as separate property. This could equally apply by the family court regards separate matrimonial property.
The ongoing oversight of a professional such as a lawyer as a trustee will help to ensure that the trust does operate properly. This is not expensive; for a similar trust I prepare annual trust (including financial) statements which included trust minutes which are signed by two (non-professional) trustees and then provided to the lawyer as the third trustee who holds the statements. Over quite a fair period of doing this, the lawyer has not charged a fee although he has carried out trust work (sale of a property) in the interim.
Due to the risks, I recommend the involvement of professional oversight to ensure ongoing trust obligations are meet such as the new requirements relating to reporting - otherwise one could well be putting the legitimacy of the trust at risk for minimal savings.
However, each to their own.
One can still engage a lawyer to do all of the above without being a trustee.
That’s my point.
I recall a frustrated friend who couldn’t even get $10 from the trust to buy a beneficiary a birthday present without the Lawyer sign off.
Not missing the point.
A professional trust.makes not a dot of difference to the argument that a trust is a sham - which I assume is the concern you have. I can’t recall when NZ Courts have overturned a trust on the basis of it being a sham due to lack of professional trustee.
Do you know of any?
rastus
It is common practice for the family court to disregard a trust under certain conditions meaning that trusts are not bullet proof and that professional oversight or involvement is highly recommended. A quick google which includes illustrations of some of the pitfalls/issues that can negate the protection of a trust:
https://www.cavell.co.nz/news-opinions/when-separation-beats-trust-prot…
Of the four trusts I am aware of where a lawyer is a trustee, it is ridiculous to suggest that a lawyer is interested in controlling a trust's affairs to the extent he/she will be required to sign off a $10 expenditure. In practice one or more trustees will have authority to operate the day-to-day affairs of the trust and a lawyer as a non-beneficiary trustee has little interest in such decisions. You have been very much misinformed.
My wife (second marriage for both) had a trust prior to us meeting with her lawyer as a trustee. The trust assets included a house and considerable investments including a rental property; she had authority to operate on behalf of the trust regarding such matters as maintenance costs for both houses, managing tenancies, choosing cash investment options, and had single signature authority to operate the trust's bank accounts . . . considerably more than a $10 birthday card.
its always interesting to see the lengths people go to to avoid paying their share of tax...when those same people often criticise the 'dole bludger' who want something for nothing...just pay the tax because you really haven't done anything to earn the capital gain...hypocrites I say..
msp
A flat trust rate of 33cents means that other than those earning above the top tax rate of $180,000 there is no tax advantage for most. My understanding is that IRD are looking at such cases where income is assigned to a trust and that these are being challenged by them - from memory there was a case involving some surgeons (?) in Christchurch.
Yes, protection of assets related to aged care is a concern . . . however even MSD is looking critically at such trusts and this has reached the courts. It is seemingly currently in a grey area and a need to ensure that the trust to have been properly managed and that an application may likely need legal support.
The Family Court is also looking critically at trusts and some have found that there isn’t the “protection” of assets one thought.
Trusts have a place such as joint property - such as a family owning a shared Bach/holiday home.
As the article points out, recent requirements are making trusts unwieldy for many and they are losing popularity. I hear that lawyers are now tending to advise against setting up a trust unless there is clear demonstrable reason for doing so.
protection of assets related to aged care is a concern
It's a bit of an indictment on parts of society that this has been a thing, though, really. All that criticism of beneficiaries, yet when push comes to shove so many in society are eager to live off the wealth of others rather than paying their way.
It's been a have your cake and eat it too approach: vote for lower taxes for oneself as much as possible, then use trusts and other structuring to try to work around the effects of that and access taxpayers' money when one decides publicly funded services aren't up to scratch.
A more ethical person might vote for the funding society to the level we would want to serve us in our time of need.
Do you think this rationale applies to companies and LTC's? For example, if buying a property in Acme Ltd, but then Acme becomes a LTC.. in the exact same ownership.. don't think that resets the brightline? The entity remains Acme Ltd the whole time.
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