Land Values – Don’t Cut Your Cake Before It’s 10 Years Old (Summer 2008)

The rampant increase in land values during the past few years has created a few goldmines for those carving up and selling land. Historically the IRD has paid little attention to this area, but that’s likely to change so it would be wise to consider the question of tax liability before IRD does.

The following is a brief overview on some of the more relevant rules in relation to developing and dividing land.

Best tax-wise

Essentially, if you haven’t purchased land to sell for a profit, the longer you hold it the better your position is from a tax point of view. If that period is more than 10 years, the profit on the sale will only be taxable in limited circumstances. The 10-year period doesn’t start from when the property purchase settles it runs from the date the agreement goes unconditional.

Income Tax legislation may capture profit from “an undertaking or schemeā€¦begun within 10 years”. If the land has been held for less than 10 years, the time, money and effort put into carrying out the subdivision will determine if the profit is taxable. If the work required to compete the subdivision is “minor”
the profit won’t be taxable. If it is not minor, in other words “more than minor” the profit will be taxable.

The use of the word “minor” in the tax legislation causes a few problems for the average person and the tax specialists alike, as it is subjective. What you might consider “minor” the IRD might onsider “more than minor”.

Case law is used as a guide, but there hasn’t been a court case in recent years involving the modern trend of subdividing rural land into three to five sections. Every case is unique and the answer depends on its own facts, so the prudent person would get some advice from a tax professional on their proposed plan.

Subdivide with care

If you decide that waiting until the 10 year period has passed is the answer, you need to be careful that you don’t “commence” subdivision before the 10 year period runs out, as it will still be taxable. Deciding when a subdivision commenced is also tricky, so it best to do nothing if you can wait. If the land has been held for more than 10 years, the scheme can’t be what is referred to as a “major development” if it is to remain non-taxable. Major developments refer to the types of subdivisions you find on the edge of most cities, where the residential housing is slowly devouring neighbouring rural land.

This level of subdivision will often require roading, contouring, footpaths, streetlights and drainage.

More considerations

As a further sting in the tail, you may encounter an unexpected tax bill if you sell land within 10 years of acquisition, even if you have not subdivided it. If you sell your land at a profit, and at least 20 percent of that profit arises because of a change (or the likelihood of a change) to the legal nature of the land, some of the profit may be taxable.

The types of changes include a zoning change, or a change in respect to the land made under the Resource Management Act. However the taxable profit is reduced depending on the number of years it has been held, at the rate of 10 percent per year.

If the proceeds of a land sale are taxable for any of the reasons discussed above, there are exclusions that may apply. But that’s another story!

Published in WINE Hawke’s Bay Summer 2008.

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