Rounding up our series on the three main worries for taxpayers, we discuss property.

So, you now know how to claim your car expenses on your tax return, and are reasonably confident that you can now manage your share investments without incurring the wrath of SARS.

But the one thing that really keeps you awake at night is how SARS views your investment in property.

The areas that concern taxpayers the most are Capital Gains Tax (CGT) when the property is sold, particularly when such property is the home in which you live; and how rental income is taxed.

Capital Gains Tax

Firstly, let’s look at CGT. If you sell the property in which you live (known in ‘tax-speak’ as your primary residence), then the first R2 million of any profits that you make on the sale is exempt from CGT. Since the general rule of CGT is that only gains accruing from 1 October 2001 onwards are subject to this tax, you will have to be living in some really fancy real estate for this tax to worry you too much.

However, if the property being sold is used for the purposes of trade (e.g., to earn rental income), then the gains made from the date of purchase (or 1 October 2001, whichever is later) will be subject to CGT.  But even then, your investment decision should not be swayed too much by CGT, since it is only the gains that are taxed, and then only at a maximum effective rate of 18% (in the case of individuals).

Bear in mind that if you used a portion of your home for business purposes (e.g., as a home office), the primary residence exemption needs to be apportioned between the residential and business portions of your property.  If the portion used for business purposes was not used for the full period of time since 1 October 2001, this apportionment needs to be done on a time basis as well.  So, you might find that the CGT bill in relation to the portion used for business purposes is actually not that large.

The other thing to remember is that the primary residence exemption is available to natural persons only.  If your home is housed in a corporate structure such as a trust, company, or close corporation, the exemption will not be applicable, and the full gain will be subject to CGT at the applicable effective rate (36% for trusts, and 21.6% in the case of companies and close corporations).

Income tax

The recent property boom has resulted in many people investing in rental properties, and the most common question that is asked is: What is the tax impact?

Rental income falls within the so-called ‘gross income’ definition contained in Section 1 of the Income Tax Act, and since the Act does not contain any exemptions relating to rent, the amount received is therefore fully taxable.

However, Section 11 provides that any expenses incurred in the production of such income will be allowed as a deduction for tax purposes.  So, any maintenance costs, municipal rates, electricity and water (to the extent that this is not recovered from your tenants), rental collection commissions, interest on the bond used to purchase the property, and the like can be claimed as a deduction.

This section only applies to expenses of a ‘consumption’ nature, which means that any improvements made to the property cannot be claimed.  However, the cost of such improvements is added to the ‘base cost’ of the property when it is sold, and is thus taken into account when calculating your CGT liability.

But be careful: Don’t think that you can go out and buy one of those ‘renovator’s dreams’, spend a whole chunk of cash fixing it up, and expect to claim the cost of such ‘repairs’ against your rental income.

The courts have held over the years that for an expense to be classified as a repair, it needs to be incurred in order to restore the asset to its former state.  In this case, the ‘former state’ will be the condition in which the property was first purchased, and any expenses required to get it up to scratch will therefore be considered as improvements.

Having said that, should you be unfortunate enough to get one of those ‘tenants from hell’ who completely wrecks your property, and you end up having to spend a fortune to get the place liveable for the next tenant, there is at least some relief in that the cost of such repairs will be allowable as a tax deduction.

Finally, if your income exceeds the level at which the maximum marginal rate of tax (45%) kicks in (currently R1 817 000 per annum), and you are making a loss from your rental property, then you need to watch out for Section 20A. This section, which contains the so-called ‘ring-fencing’ provisions, provides that you will not be able to set off such a loss against other taxable income.

However, for this provision to be applicable, you need to be making losses for a period of time. At least three years of losses need to elapse before SARS can consider invoking this section. It also cannot be invoked if your marginal tax rate is less than the maximum.

 

Written by Steven Jones

Steven Jones is a retired tax practitioner and member of the South African Institute of Professional Accountants.

While every reasonable effort is taken to ensure the accuracy and soundness of the contents of this publication, neither writers of articles nor the publisher will bear any responsibility for the consequences of any actions based on information or recommendations contained herein. Our material is for informational purposes.