Capital gains tax: A potential 'nightmare' for lifestyle block owners

In part four of a Business Herald series on the effects of a capital gains tax, Andrea Fox looks into what it would mean for lifestyle block owners.

Status quo:

There is no capital gains tax on lifestyle blocks.

The Real Estate Institute says there are 178,778 properties classified as "lifestyle" in New Zealand.

REINZ data shows 92 per cent of lifestyle blocks sold in New Zealand last year were bigger than 4500sqm, which is the area of family home deemed exempt from a capital gains tax (CGT) by the Tax Working Group (TWG).

The median size of properties sold last year was 20,000sqm, says REINZ.

However figures from Land Information released to the National Party show there are 403,883 freehold properties around New Zealand that are greater than 4500sqm.

Many lifestyle properties are on unproductive land, having been subdivided off by farmers because the land does not make a return.

What's proposed:

The TWG proposes a CGT would apply to profit after the sale of residential property and all land and buildings except the family home.

The tax rate would be set at the income-earner's top tax rate, likely to be 33 per cent for most. It is proposed CGT would apply after April 1, 2021.

What REINZ thinks:

If sales of lifestyle properties last year was indicative of a normal year's sales, a similar portion of the market would be likely to have to pay a CGT on the portion of their land that is greater than 4500sqm, says chief executive Bindi Norwell.

She predicts if a CGT is introduced many lifestyle property owners will sell ahead of 2021.
"Some properties will have been in families a number of years - it'll be heartwrenching."

We could see "the mansion effect", Norwell says.

"They will invest everything in their own properties and not put it into other assets. They'll have all their eggs in one basket and over-capitalise. In terms of an investment portfolio, that's probably not the best thing."

What the experts say:

Tax expert and executive chairman of Caniwi Capital, Troy Bowker, says the lifestyle block sector would be up for many millions of dollars in valuer and accountants' bills if the proposed CGT is introduced.

He says CGT might sound a simple concept but "it gets complicated really quickly".

Bowker, who has a Masters degree in tax policy and economics and is a chartered accountant, says the situation is a potential "nightmare" for lifestyle block owners, many of whom have built or bought on unproductive land because they just want to live in the country.

"It's actually land that's been subdivided because it wasn't productive. They put a nice house on it and suddenly a CGT comes in so they're off to a valuer.

"They'll have to do a basic apportionment (for IRD) which means getting a proper valuation. Say they've got 6000sqm of land - they're not going to divide 1500sqm by 6000sqm to get an apportionment (for tax liability) because the rest of their land could be worth one dollar or very little. So they have to get a valuations and that's where it gets complex.

"Because if you don't get a valuation you're stuck with whatever the IRD tells you which is based on some sort of apportionment," says Bowker.

"You could have a gain of $500,000 in 10 years and suddenly at the end of it you're paying a CGT on a portion of land the IRD deems to be valuable, when in fact it could be worthless.

"The only way to defend yourself is to get a proper valuation."

Bowker says a valuation won't leave change out of $5000.

He says the owner will have to ask the valuer what is the house worth, what is the 4500sqm round the house worth, and what is the rest of it worth?

"That's three questions and that's not cheap."

And there's more bad news, says Bowker.

For work on the land area that is subject to a CGT, such as fencing, tree planting or water reticulation, the IRD will require a tax return done every year.

"If you don't do a tax return for improvements you don't get a tax deduction when you sell it.

"These are people who are just salary and wage earners. They don't use top accountants for their tax returns - they just own a lifestyle block.

"So Labour is proposing a situation where simple lifestyle block owners in order to do simple things like put water on their land or fences or driveways are going to have to apportion the improvements every year.

"It's a nightmare. They (TWG) haven't thought it through whatsoever, and they're going to cost lifestyle block owners thousands and thousands."

"There'll be a new industry around people trying to make sure they don't get landed with a lot of tax for something that should be there in the first place."

Tax Working Group member Geof Nightingale, a tax partner at PwC, has a different take.

Nightingale says "you get into very arbitrary territory" when designing a capital gains tax which excludes the family home and having to define what a family home is.

"The working group landed on 4500sq m because that is the current definition of land that goes with a house that presents for GST purposes when for example, a farm is sold.

"The working group also said 4500sq m was just a suggestion [when] you define what amount of land is reasonable for the occupation and enjoyment of the actual house - in some cases it might be less or might be more.

"That is going to be an area of real interest in submissions if the Government takes forward any of this proposal. What is the family home and what land comes with it is going to be the debate."

Nightingale says using the REINZ's median lifestyle block size of 20,000sq m as an example, it would mean the house included on 4500sq m of land would not be subject to a capital gains tax.

"But the 15,500sq m round it would potentially be subject to capital gains tax on any gain that related to that land."

In the hope of showing the "true potential impact rather than the discourse that's emerging on social media that once you're over 4500sq m the whole thing is taxed", Nightingale offered the following example.

"Let's say I bought a lifestyle property out at Helensville 10 years ago for $1 million, and it sits on 10,000sq m - so it's a four-bedroom house on 10,000sq m of land.

"If this [CGT] comes in on the first of April 2021, let's say that lifestyle property is now worth $2.5 million total, which is not unrealistic after this time.

"Along comes the valuer and says the value of the house and 4500sq m of land is actually $2 million and the value of the other 5500sq m of land left is half a million dollars.

"Then the cost base of your capital gains tax for those assets becomes half a million dollars."

"Let's say in 2023 that lifestyle property holder sells the whole block for $3 million. They are then going to have to apportion that $3 million.

"The valuer might say now the house is worth $2.2 million and the 5500sq m of land under capital gains tax is $800,000 proceeds.

"The cost base is established when the asset is transitioned into the regime of half a million dollars so you have a taxable gain now of $300,000 and that is going to be taxed at your marginal rate."

Nightingale said while the property owners were never going to say that was a good idea, the example showed the true potential impact.