Taken from article originally published 29th November 2023

As we’ve covered previously, US persons living in New Zealand may be subject to a capital gains tax on the sale of their home or rental property.

As a reminder, a US person is any US citizen, green card holder, or individual who meets the Substantial Presence Test.

Whilst New Zealand doesn’t have a comprehensive capital gains tax, and is unlikely to have one until at least the next government, US persons can still be subject to US tax on capital gains.

But, I’m frequently asked the question: “What happens if I sell my home and purchase another immediately after? Can I defer the capital gain being realized?”.

The answer here is no, not anymore, but yes for business property.

But, I deferred the tax on my home sale back when I lived in the USA?

Previously, US citizens could defer recognizing any capital gains income on the sale of their home, provided they used the proceeds to purchase another home within 12 months.

In essence, this meant you could:

• Purchase a home

• Let it increase in value

• Sell and purchase a more expensive home

• Let it increase in value

• Sell and purchase an even more expensive home

And all the while, no capital gains tax would be realized. The basis in the property (ie the original purchase price) would stay the same throughout this process. If indeed the owner did eventually sell their home and not purchase another, then all of the capital gains since the first property would be realized at that time, resulting in a large capital gains tax bill.

As a result, the most popular system here was for the home to never be sold, and instead left to an estate whereby it would (in most cases) be distributed tax free to the beneficiaries, who would either sell (no tax) or begin the process above all over again.

As you can see, this wasn’t exactly favourable from the IRS’ perspective, as it did result in many individuals being able to continuously defer capital gains tax until their passing, and the IRS never taxing the gains.

This regulation was repealed in 1997, and as a result you can no longer defer capital gains tax on the sale of your home. The IRS did however double the exemption amount for the sale of a main home up to $250,000USD, meaning capital gains are generally only taxable above this amount (conditions apply).

When you sell, and purchase a new property, gains made over the original purchase price, are recognized and taxable at the time of sale.

I’ve heard there is something called a 1031 exchange? Can I use that?

A section 1031 exchange is in essence, very similar to the previous rule which existed above. However, this rule is only available to real estate investors.

Section 1031 covers “like-kind exchanges”, meaning that the proceeds from the sale of one property are then used to purchase substantially similar property.

In the case of an investor purchasing a residential apartment, selling it, and purchasing a new residential apartment, they would be able to defer any capital gains made on the sale of the original apartment.

If however, the investor sold the residential apartment and used the funds to purchase a warehouse, it is unlikely that section 1031 can be used.

So can I use section 1031 for my main home?

No, section 1031 exchanges can only be used on property held for investment or business purposes. Living in the property would not meet this requirement.

So, I can use it for my rental properties?

Yes, it can be used for rental properties. However, there is a risk of classifying yourself as a real estate investor (ie holding a property solely for sale) with regards to NZ tax implications.

It is possible that even when section 1031 is used to defer capital gains on the sale of a property (US taxation), New Zealand tax could still apply. In this case, the NZ tax would not be used to offset the US tax through foreign tax credits, meaning ultimately you pay tax to both countries (when the property is eventually sold and no new property is purchased).

As a result, section 1031 exchanges are quite rarely taken advantage of by New Zealand based US citizens.

This situation can become quite complex when considering NZ “in-trade” rules, and professional tax advice should always be sought.

If you’d like to understand any of the above further, reach out to us today – 09-242-3445 – info@usatax.nz or http://usatax.nz