Land banking and tax

There has been a great deal of attention given to Auckland’s Unitary Plan. For some landowners, that will be good news financially as the value of their property rises to reflect a more intensive economic use. There may however be a tax fishhook that some will not see coming.

Here’s an abbreviated extract of the relevant clause (CB14) in the Income Tax Act. It says,

(1) An amount that a person derives from disposing of land is income of the person if…
(b)the person disposed of the land within 10 years of acquiring it; and…
(d) at least 20% of the excess [above cost] arises from a factor, or more than 1 factor, that—
(i) relates to the land; and
(ii) is described in subsection (2); and
(iii) occurs after the person acquired the land…

(2) The factors referred to in subsection (1)(d) are—
(a) the rules of an operative district plan under the Resource Management Act 1991 [or likely change in rules]…
(e) a consent granted under the Resource Management Act 1991 [or likelihood of a consent]…
(g) a decision [or likely decision] of the Environment Court made under the Resource Management Act 1991…
(i) the removal ([or likely removal] of a condition, covenant, designation, heritage order, obligation, prohibition, or restriction under the Resource Management Act 1991…
(k) an occurrence [or likely occurrence] of a similar nature to any of the occurrences described in any of paragraphs (a) to (j):

Rendering this down into ordinary speak, it means if within 10 years of purchasing land, the value rises AND that rise is at least 20% attributable to a planning issue, then the gain – ALL of the gain in value – will become taxable as ordinary income.

Another twist in all of this is that the tax liability is reduced by 10% for every year the land is held. So if the land is held for say five years, then the tax liability is reduced by 50%, and if the land is owned for more than 10 years, then no tax would be payable, even if some or all of the gain in value derives from zoning changes.

You will notice this net also catches gains from re-zoning even if the re-zoning change has yet to take place. The whole issue of apportioning gains is highly subjective so great reliance is likely to be placed on valuation evidence by a registered valuer.

There are a couple of exclusions allowed by the Act. The first is where the land is owned by an individual(s) and is their place of residence, and if the land is sold within 10 years the person who acquires it also intends using it in the same manner. This exclusion does not apply to residential land owned by a family trust.

The second exclusion is where the land is farmed, and if sold within 10 years is sold to a purchaser who continues to farm the land.

Note that the intention test still applies, so if land is bought with the intention of resale at a profit then any gain in value realised on resale would be caught in the tax net regardless of how long the land is owned.

Apparently the IRD is going to become more vigilant in this area. The numbers are quite large as can be the penalties so if in doubt, seek professional tax advice.

It is often reported that property investors enjoy tax advantages not available to others. My view is property owners face a more stringent and targeted tax regime than other investors, such as sharemarket investors and business owners. The 10-year zoning change rule is one such example.

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