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Unlike the family home, investment properties are not inherently relationship property under the Property (Relationships) Act 1976 (“Act”).
If an investment property was acquired:
·prior to the relationship and not in contemplation of the relationship; or
·with separate property (such as inheritance funds or with funds distributed from a trust),
then the investment property is the separate property of the owner partner and, should the relationship deteriorate, the owner partner may retain full ownership of the property without having to make any provision for the non-owner partner in respect of the property.
However, many people are unaware that although an investment property may be their separate property under the Act, a non-owner partner may still have a claim against any capital gain on the investment property. In the current property market, capital gains can be significant.
The case of KRJ v RK [2013] NZFC 823 is a good example of when a non-owner partner can benefit from a capital gain made on the sale of separate property of the other partner. In this case the husband owned a property in Poolburn, Central Otago that was his separate property under the Act. Together, the husband and wife renovated the property which included structural improvements, building a farming shed on the property, painting the home and laying new carpet. These renovations cost approximately $8,000 and were paid for with the husband’s income. The property was sold and a capital gain of $167,000 was realised. Later, the husband and wife separated. The wife initiated relationship property proceedings in the local Family Court and, in respect of the $167,000 capital gain, the Court held that it was relationship property to which the wife was entitled to half.
Given that separate property is not subject to the equal sharing regime under the Act, why was the wife able to share in the capital gain of her husband’s separate property?
Section 9A(1) of the Act provides that any increase in the value of separate property that is attributable (wholly or in part) to the application of relationship property, is relationship property. Therefore, if you apply your income, which is relationship property, to an investment property, any increase in the value of your investment property (or your shareholding in the company which owns the investment property) is relationship property to be shared equally by you and your partner.
Section 9A was applied in KRJ v RK and, as the husband used his income (relationship property) to pay for renovations, the capital gain of his Central Otago home was relationship property to which his wife was entitled to half. What was interesting in this case is that the Court conceded that the capital gain was due to the inflationary property market, not the $8,000 worth of capital improvements. Regardless, the wife was entitled to half of the capital gain.
It should be noted that the Court will not make an order under section 9A if only a “trivial” amount of relationship property is applied. What is considered to be a trivial amount is fact specific and will depend on a comparison of the amount of relationship property spent on the property and the increase of the property value from other forces. Judicial decisions such as KRJ v RK suggest that even a small contribution will be considered by the Court to be more than trivial.
To avoid sharing an increase in the value of separate property, you must only use separate property to fund improvements. The lesson is not to mix relationship property with your separate property.
…but you’re not safe yet! Even though a partner may take steps to avoid a section 9A(1) claim by choosing not to apply their income to their separate property, a non-owner may be able to lodge a claim under section 9A(2).
Section 9A(2) provides that if any increase in the value of separate property is attributable (wholly or in part) to the actions of the other partner, then the increase in value of that separate property is to be shared by the partners in accordance with the contribution of each partner. Therefore, if the non-owner partner assists with renovations that improve an investment property owned by the other partner, the non-owner partner will be entitled to a share in any capital gain on the investment property. Under section 9A(2) a non-owner partner might be awarded less than half of the capital gain if the gain was primarily attributable to an inflationary property market. Awards under section 9A(2) of the Act are generally lower than under section 9A(1).
…and it doesn’t end there! Under section 9A(2), a non-owner partner does not need to show they worked to improve or renovate the separate property. Section 9A(2) recognises both direct and indirect actions of the non-owner partner. Indirect actions include management of the household and care of children. Indirect actions are taken into account as they enable the owner partner to spend more time and/or money improving their separate property.
For example, if we tweak the facts of KRJ v RK so that:
·the husband did not use his personal income to renovate his investment property but used separate property instead, for example inheritance funds; and
·his wife did not directly help with renovating the property but instead stayed at home looking after their children and tending to the household generally,
there would still be claim. By tending to the children and managing the household, the wife would enable her husband to spend more of his time renovating his investment property rather than sharing in the household duties. This is a contribution that would entitle her to an award under section 9A(2) of the Act.
It is important to understand that if the Property (Relationships) Act applies to you, it can be difficult to prevent your partner from benefiting in some way from your separate property unless you silo property completely. To get around this we advise that you enter into a relationship property (contracting out) agreement or, if you are not currently in a relationship, transfer assets such as investment properties and company shares out of your personal name and into trust ownership.
If you would like to protect your property from a section 9A claim, our Private Wealth Team would be happy to meet with you to discuss your various options to achieve protection. Please email lawyers@heskethhenry.co.nz
