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Capital Gains Tax and lifestyle blocks

Note: I am not a tax expert, this article is an outline of my understanding of the proposals and should not be regarded as expert advice.

The Tax Working Group (TWG) was set up by the current government to look at the fairness, balance and structure of the tax system. On 21st February the TWG released their final report with recommendations.

While the report covers a number of tax issues, including environmental taxes, the immediate focus has been on Capital Gains Tax (CGT). This article is purely a look at the implications of the proposed CGT on lifestyle farms.


The arguments in favour of CGT:

  • it is a fairer system as many people, disproportionately the wealthy, currently make income that is not taxed.
  • having a CGT would mean less reliance on income tax and GST.
  • the lack of CGT skews investment to areas that are not taxed – eg property.
  • many other countries have a CGT for these reasons.

What the recommendations say

  • The taxation of capital gains should be extended to include land, including improvements to land (other than the excluded home).
  • Tax should be paid on the realisation date – most of the time this will be when the asset is sold.

The excluded home

  • An excluded home should be defined as the place that a person owns, where they choose to make their home by reason of family or personal relations or for other domestic or personal reasons
  • The excluded home should include the land under the house and the land around the house up to the lesser of 4,500m² or the amount required for the reasonable occupation and enjoyment of the house.
  • Where the total area of the property is greater than 4,500m², or is not required for the reasonable occupation and enjoyment of the house, the gain on sale should be apportioned on a reasonable basis.

The example that is used in the TWG final report is as follows:

"The Farmers own a 100-acre sheep farm. Approximately 4,000m2 of the land comprises the Farmers' house and gardens. The remainder of the property is devoted to business purposes.
Only the area of the house and gardens is part of the excluded home. When the Farmers sell the land, they obtain a valuation of the area comprising the house and gardens, compared to the rest of the property. The valuation confirms that the house and gardens make up approximately 15% of the value of the whole farm.
On that basis, only 15% of the total gain on sale can be allocated to the excluded home."

Potential impact on lifestyle farmers if this recommendation is made into law.

  • Many lifestyle farms will be subject to CGT.
  • The day the CGT comes into effect will be 'Valuation Day' and properties will be valued as of that date. This will not be done immediately as it would be impractical but over a period of years.
  • Valuation methods that may be used include individual valuation, Rating Value, or comaparable property values such as QV valuation.
  • When the property is sold a new valuation will assess the value of the 'excluded home'.
  • The difference between the sale price and valuation day value, less the 'excluded home' value, will be taxed at the taxpayer's marginal rate of tax.

Issues

  • The terms of reference for the TWG did not allow it to assess a CGT on the family home so those opting for a small house on a block of land will pay CGT when a McMansion on a small block of land will be exempt. This creates rather than removes inequity.
  • The issue of improvements is unclear. The final report says:

As a general proposition, expenditure incurred in acquiring an included asset will be deductible at the time of sale. Similarly, costs incurred after acquisition on making improvements to the asset will also be deductible from the sale proceeds.

But there is no clarity about what this includes. On the face of it, it would include adding a barn to a property but what about fertiliser? What about the hours of work that go into maintaining paddocks in a good condition? These have an impact on the sale value so will they be counted as costs of improvement?

  • If so, many lifestyle blocks may actually make a nominal loss on sale which would result in tax credits...but don't hold your breath!
    Without more details it's impossible to say but potentially the value of lifestyle farms will drop.

What happens next?

  • This report will be considered by the government.
  • Cabinet will make a decision on any tax changes.
  • There will be a period of public consultation.
  • The final bill (if any) will be presented to Parliament and go through the Select Committee process as usual.
  • No changes will be implemented prior to the next election.

References:
https://taxworkinggroup.govt.nz/resources/future-tax-final-report

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