Your Options when a Property Trade ends up as a Rental
Things don't always go according to plan. This is particularily true with a number of property traders I've dealt with over the years.
I've seen some clients purchase a property with every intention of renovating and onselling that property within a few months. Sometimes the property market has dropped suddenly (ie 2007 GPC), sometimes the market shows strenth so the client sees more value in holding onto the property, sometimes the property wasn't purchased at enough of a discount and sometimes the original budget was simple too optimistic. For one or more of those reasons, the property is rented out and essentially becomes a long term rental.
What are the GST implications of this?
As the property was purchased as a trade, GST was claimed on the purchase. As that property is now earning residential rent which is a GST exempt activity, a periodic GST adjustment is required to reflect the mixed GST use of the property.
This GST adjustment was previously outlined in the Lundy tax case althrough GST laws with a new calculation became effective from 1 April 2011. Doing the GST adjustments while keeping the original GST claim is allowed as the property is mixed use. However, the IRD's view is that if that property is taken off the market, then it is no longer a trade so the GST should be paid back to the IRD based on the market value of the property at that time. This would be a major cashflow issue so you are best to keep the property on the market if you don't want to run into that problem.
I often get asked by clients in this situation, what happens if I now want the property to be a rental only? Should I transfer the property to another entity for income tax or GST purposes?
At the time your permanently take the property off the market, you are required to pay GST to the IRD based on the market value of the property. This would be the same result if you were to transfer the property to another investment entity of yours. As such, there is no GST benefit in transferring the property to another entity as it is done at market value either way.
What are the income tax implications of this?
As the property was purchased as a trade, any profit is subject to income tax. Marking the property a rental will not stop that requirement when the property is ultimately sold. Transferring the property to another entity won't help either as section CD 15 of the Income Tax Act 2007 states that the new entity would take on the old entities income tax status as they would be considered to be associated entities.
The only benefit I can see from transferring the property to another entity would be the ability to offset any ongoing tax loss against your personal income if th eproperty is currently onwed under a trust or normal company where losses are not offset against your personal income.
Disclaimer: The above article is general in nature and we recommend you seek professional advice tailored to your specific personal situation.