Money: Tax treatment depends on nature of work

By Denham Martin

Taxwise


I am thinking of buying a small block of land and subdividing it into two lots. I would like to keep one lot and build a home for myself on it, and erect units on the other lot to rent out. Will I pay income tax on the gains on the land when I eventually sell up? Should I buy the land in my own name or through a trust?

AK, Devonport There are a number of factors that can lead to income tax being payable on the profits made on sales of land. You are at risk if:
* You buy the land with the intention of resale.

* You or an associated person are a dealer in land.

* You or an associated person are in the business of erecting buildings;

* You or an associated person are in the business of developing or sub-dividing land.

* You undertake a subdivision or development of the land within 10 years of acquiring the land.

* You undertake a major subdivision or development of the land.

* You sell the land within 10 years of acquiring it and a large part of the gains were due to zoning changes, resource consents or similar factors.

The following comments assume that you are not a dealer, developer or builder in your own name and that you are not associated with persons or entities that carry on these activities. An association will exist between you and your close relatives and also can arise through you and/or close relatives owning shares in companies, being in partnerships, or being beneficiaries of trusts. We also assume that your question arises from you realising that you may want to sell the land at some future time rather than from you having a specific intention to resell at the time of buying it.

If you subdivide the land into two lots within 10 years of acquiring it, your liability to pay income tax on the proceeds of any subsequent sale of the land depends upon a number of factors. The first is whether the work undertaken in carrying out the subdivision is more than of a "minor nature". Case law has established that not very much work is required to exceed the "minor nature" threshold and that it will be rare for the work involved in a simple subdivision such as yours not to be caught. Accordingly, your subdivision will probably not be of a "minor nature" and, therefore, it is likely to be caught by the provision.

The second factor is whether the provisos to the provision in question can be invoked such that the provision will not apply. The particular provisos that are relevant to your situation are those in respect of (i) land that is used as a residence by the taxpayer and any member of the taxpayer's family living with the taxpayer, and (ii) the deriving by the taxpayer of rental from the land.

In order to come within either of these exemptions, your purpose at the time of carrying out the subdivision must be to use the land for the exempt purpose - for either personal residency or rental purposes. Further, you must be able to evidence your intention. The provision does not specify a minimum period of time for which the land must be used for the exempt purposes. Obviously, if the land was used for these purposes only for a short period before selling it, the inference could be drawn that you always intended to sell the land.

Whether you purchase the land in your own name or through a trust will influence whether the personal residency exemption will be available. The Taxation Review Authority has held that it will not be available where a trust owns the land, as a trust by its nature cannot reside on land. However, had you been concerned with, for example, the dealer provision instead of the minor subdivision provision, the personal residency exemption that applies to that provision is worded wide enough to cover land owned by trusts.

Thus, on the limited information provided it would seem that would be preferable to purchase the land in your own name rather than through a trust, in order to benefit from both the personal residency and the rental exemptions. However, a full review of all facts may show that purchasing through a trust is better, for example, if the assumptions noted above are incorrect and there exist associated persons concerns. Consequently, you should only rely on advice that has considered the full factual background of your specific case.

* Denham Martin is the principal of Denham Martin & Associates, lawyers specialising in advice on taxation and related matters.