In this month’s article, which is a continuation of last month’s on associated persons “traps”, I highlight another two traps readers should be aware of.

Trap 3 – Tainting For Life

Friends, Jesse and Skylar, are 50% shareholders in a property development company called JS Developments Limited. They are currently developing a property by subdividing it into four and constructing four new dwellings on the four lots. They plan to sell three, with Jesse retaining one as his home. The plan is to have the company sell this lot upon completion to Jesse’s family trust. They understand that the company will pay GST on the sale and income tax if there is a profit realised. Jesse’s trust is not GST registered and will not have a GST liability in relation to the property should it sell it in the future. However, Jesse has heard that the trust may have to pay income tax if it sells the property for a gain in the future. This surprises Jesse.

Jesse’s fears are well founded. Where a property is moved between associated parties, the associated purchaser is basically regarded as having the tax characteristics of the original owner in the context of that property. In other words, the property is tainted as a development property by virtue of the company having bought the land initially for development purposes, and that tainting continues to stay attached to the property for as long as it is moved between associated persons. Another way of saying this is that the property is tainted for life. A few years ago, it was suggested this aspect of the associated persons rules might be reviewed, but there has been no law change to date, so it is an issue. It would apply equally if the property were moved out of a development company and into an associated rental company for long-term rental purposes.

‘Be careful about restructuring the ownership of an ex-home or a rental property, even if there are advantages in doing so’

Trap 4 - Bright-Line Clock Reset

Jimmy and Kim want to buy a new home and convert their existing home to rental use. They have owned and lived in the existing home for 15 years. They have received advice that they should sell the existing home into a new rental company at the same time as settling the new purchase. They do not believe there would be any adverse tax consequences in doing so given that they have lived in the property for so long. However, they wonder whether transferring it into a company means that a future sale is more likely to be taxable.

In some respects, the associated persons rules are helpful in a situation like this because for most of the land tax provisions, the new rental company inherits the original acquisition date so is seen as owning the property for 15 years. This decreases the likelihood of any future sale giving rise to a taxable gain. However, there is one provision where this deemed acquisition date does not hold and that is the bright-line rule. As readers are likely aware, residential property bought and sold within a five-year period is caught by the bright-line rule. When restructuring ownership of a property like this, you need to be aware that the bright-line clock resets. This means if the company were to sell the ex-home within five years of it being transferred into the company, any gain realised within the company is taxable.

Be careful about restructuring the ownership of an ex-home or a rental property, even if there are advantages in doing so, because sale within five years could give rise to a taxable gain that would not have existed otherwise.

Summary

There are a variety of nasty traps to catch unwary taxpayers carrying out transactions between associated entities. These traps exist both in the context of income tax and GST. The antidote is to get good professional advice before engaging in such transactions.