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.
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.
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.
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. ■
We have an upcoming CPD event in this area.