Understanding Tax Allocation Rules in Sale & Purchase Agreements: What Property Buyers and Sellers Need to Know
When buying or selling property in New Zealand, most people focus on the purchase price and settlement details. However, there’s a crucial tax consideration that many overlook: how that purchase price gets allocated between different assets for tax purposes.
Recent changes to New Zealand tax law have introduced specific rules about asset allocation in sale and purchase agreements. These rules affect everyone from farmers selling land with improvements to business owners disposing of commercial properties. Understanding these requirements could save you significant tax headaches down the track.
What’s Changed and Why It Matters
The Inland Revenue Department (IRD) identified several concerning situations where buyers and sellers were manipulating asset allocations to gain tax advantages. These included cases where parties agreed on allocations but then used different figures in their tax returns, or where no allocation was agreed upon at all, leaving room for creative interpretation.
To address these issues, Parliament introduced new sections GC 20 and GC 21 to the Income Tax Act, applying to agreements entered into from 1 July 2021 onwards.
The New Rules Explained
Section GC 20: Agreed Allocations
When parties to a property transaction agree on how to allocate the purchase price between different assets before filing their tax returns, both parties must stick to that allocation in their tax returns. There’s no minimum threshold for this requirement – it applies regardless of the transaction size.
For example, if you’re selling a farm for $2 million and agree to allocate $1.5 million to land, $300,000 to buildings, and $200,000 to plant and equipment, both you and the buyer must use these exact figures in your respective tax returns.
Section GC 21: No Agreed Allocation
When no allocation is agreed upon beforehand, the vendor has three months after the ownership change to determine and notify both the purchaser and IRD of the allocation. The vendor must ensure that taxable property isn’t allocated at a loss-making amount.
If the vendor doesn’t meet this three-month deadline, the responsibility shifts to the purchaser, who has more flexibility in their allocation approach.
Understanding De Minimis Rules
The legislation includes some relief for smaller transactions and assets:
Transaction Threshold: If the total sale price is under $1 million and parties haven’t agreed on an allocation, the new requirements don’t apply.
Small Asset Protection: IRD cannot challenge allocations to depreciable property where:
- The original cost was less than $10,000
- The allocation falls between the asset’s adjusted tax value and original cost
- For multiple identical small assets, the total allocation is under $1 million
If no allocation is made at all, the vendor is treated as disposing of assets at market value, while the purchaser acquires them for nil value.
Market Value: The Key Concept
Central to these rules is the concept of “market value.” For GST purposes, this means the consideration a similar supply would fetch in similar circumstances when freely made between unassociated parties.
However, market value isn’t always a single number – it’s often a range. Various valuation methodologies can be applied, and factors like the asset’s nature and the circumstances of the buyer and seller can affect the final price.
When market value can’t be determined using standard criteria, IRD has the power to fix the value based on factors such as production costs, profit margins, and demand for similar goods or services.
Special Considerations for Different Property Types
Commercial Buildings vs. Residential Properties
The approach to allocation varies significantly between property types. Commercial buildings require separation between the “building core” (structural elements, foundations, plumbing, electrical systems) and separate assets like plant equipment and fit-out items.
Residential rental properties follow different rules, particularly regarding what constitutes part of the building versus separate depreciable assets. Items like plumbing and electrical wiring are typically considered part of the building, while carpets and curtains may be treated as separate assets.
Associated Party Transactions
Special restrictions apply when selling to associated parties. The buyer’s depreciable cost is limited to the lesser of their purchase cost or the seller’s original cost. Additionally, the depreciation rate cannot exceed what the seller was using.
These rules prevent artificial arrangements designed to create higher depreciation claims through inter-company transfers.
Land Improvements
Don’t forget about improvements to land, which are listed in Schedule 13 of the Income Tax Act. These include items like fences, bridges, dams, roads, and swimming pools. While land itself isn’t depreciable, these improvements are, so proper allocation is crucial.
Practical Steps for Buyers and Sellers
Before Signing: Consider engaging a professional valuer or quantity surveyor for significant transactions. The cost of obtaining proper allocations upfront is usually much less than dealing with IRD challenges later.
Document Everything: Ensure your sale and purchase agreement clearly specifies the allocation methodology or actual amounts. This documentation becomes crucial if questions arise later.
Seek Professional Advice: Tax allocation rules are complex and the consequences of getting them wrong can be significant. Professional advice is particularly important for:
- Business asset sales
- Properties with significant improvements
- Associated party transactions
- New building purchases
Meet Deadlines: If no allocation was agreed upon, remember the three-month deadline for vendors to notify IRD and the purchaser.
Depreciation on Buildings: A Temporary Return
It’s worth noting that from 2021 to 2024, tax depreciation on non-residential buildings was temporarily reintroduced at rates of 2% diminishing value or 1.5% straight line. However, from the 2025 income year, the depreciation rate for non-residential buildings returns to 0%.
This temporary change made proper allocation even more important for commercial property transactions during this period.
Key Takeaways
The new tax allocation rules represent a significant shift in how property transactions are handled for tax purposes. The key points to remember are:
- Agreement is binding: If you agree on an allocation, you must use it in your tax returns
- Time limits matter: Vendors have three months to make allocations if none were agreed
- Professional help pays off: The complexity of these rules makes professional advice valuable
- Document everything: Clear documentation in sale agreements prevents disputes
- Market value applies: All allocations must reflect genuine market values
These rules apply to all types of property transactions, from residential rentals to large commercial developments. While they may seem complex, they’re designed to ensure fair and consistent treatment of property transactions across the tax system.
The bottom line is simple: proper planning and professional advice at the outset can save significant time, money, and stress later. Don’t let tax allocation become an afterthought in your next property transaction.