TalkTax

Taxation of sale of rental properties and personal residences

In early 2009 a rental property investor was referred to Owens Tax Advisors Ltd, having bought and sold a number of residential rental properties and then been audited by IRD.  At one point IRD proposed that if the sale of rental properties amounted to a business then the sale of one or two private homes were also potentially subject to GST and income tax.

Residential exemption

As anyone with any reasonable tax knowledge is aware, a residential exemption provides that the relevant taxing provisions do not apply if [currently section CB 16]

(a)          the person acquired the land with a dwellinghouse on it; or acquired the land and erected a dwellinghouse on it; and
(b)          the dwellinghouse was occupied mainly as a residence by -the person and any member of their family living with them; or if the person is a trustee, 1 or more beneficiaries of the trust.

Exclusion where ‘pattern of transactions’

IRD then tried to argue that the residential exemption does not apply if [as provided in subsection (3)] the taxpayers had engaged in “a regular pattern of acquiring and disposing, or erecting and disposing, of dwellinghouses”.

We pointed out that two sales are no more a ‘pattern of transactions’ than two dots form a straight line, but then IRD said that the two sales of their own residences are part of the potential  ‘pattern’ of sale of rental properties.

I have never come across such an interpretation.

Looking back at the history of the legislation we noted that the 1994 equivalent read

“unless… the taxpayer engaged in the acquisition or erection of the business premises or dwelling houses, and the subsequent sale or disposition of the business premises or dwelling houses, to the extent that a regular pattern of such transactions has emerged” [our emphasis]

We suggest that the words ‘such transactions’ indicates there would need to be a pattern of sale of properties that were personally occupied, rather than a wider pattern of dwellinghouses including both rental and personal properties.

Further, in  Parry v C of IR (1984) 6 NZTC 61,820 Tompkins J said:

In considering whether there has been a regular pattern of erecting dwellinghouses and subsequent sale, the Court must consider each transaction to assess the degree of similarity each to the others. This involves considering factors such as the type and location of the sections, the type of the dwellinghouses, the method of erection, the use to which the dwellinghouses were put and, in particular, whether occupied by the objector, and any other characteristics of the transaction that may be relevant in assessing similarity.

IRD behaviour

We strongly suspect that IRD was trying to bully the taxpayer into accepting tax on sale of rental properties in return for not paying tax on the personal residences, which were clearly not taxable anyway.

IRD undertook to come back to us with a technical analysis by end of August 2009, then September 2009, then by end of November 2009 but at time of writing has not done so.

In the end IRD had to capitulate on the whole lot – there was no business of dealing in property, there was no ‘pattern of sales’, and at time of acquisition no intention of resale.

However to add insult to injury, despite full and prompt responses by the taxpayer in every instance, IRD managed to drag this audit out for over 18 months, costing the investors significantly more accounting and consulting fees than should have been necessary.  In comparison, allowing for collection of data it took us only a few days to reach our conclusion.

Questions for readers

We are very interested in any feedback as to whether:

• You have experienced IRD trying to tax private homes (in the absence of a genuine pattern of buying and selling private homes’
• You agree with our interpretation of the exemption and, and the exclusion for a pattern
• You  experience IRD dragging out audits inappropriately

Jeff Owens

Owens Tax Advisors Ltd

2 February 2010