RENTING OUT YOUR PRIMARY RESIDENCE – CGT IMPLICATIONS
Posted : 18 April 2019
This is a question that often arise from property owners. Does renting out your primary residence disqualify you from the primary residence exclusion in respect of capital gains tax (CGT)?
Obviously, where the property was never and has never been your home (and the onus will be on you to provide this), it would be folly to try to claim it was your primary residence. Rather we are talking about a case where you really did live in the property for a period and have subsequently moved out and decided to rent the property out.
Let’s say Sally purchased a flat for R1,9 million, and resided in it from January 2015 to December 2017 (3 years). On 01 January 2018, she vacated the property, moved into a house, which then becomes her primary residence.
Now let’s look at a number of scenarios for Sally:
1. She gets an offer from a buyer in January 2018 for R3 million and accepts this. This was her primary residence and she is entitled to the R2 million exclusion from CGT. So ignoring costs for the sake of simplicity, the R1,1 million gain will be not be subject to CGT.
2. She gets an offer from a buyer in January 2018 for R4 million and accepts this. Again ignoring costs, her gain is R2,1 million, but she qualifies for the exclusion and only R100 000 of the gain will be subjected to CGT. As an individual, her first R40 000 gain is exempt and a 40% inclusion rate is applied, so she is taxed on R24 000 of the total gain (at her marginal tax rate).
3. She moves out, but places a tenant in the property from January 2018 to December 2018, then sells the property in January 2019. The fact that a former primary residence is later used for rental income, does not mean that the exclusion is completely lost. However, the exclusion must be apportioned between the period that the property was used as a primary residence and the period that it was used for trade (ie rental income). Since Sally lived in the property for 3 years and rented it out for 1 year, ¾ of the exclusion will be allowable on sale. Assuming the R4 million selling price, and a gain of R2,1 million, the exclusion will be R1,5 million. R600 000 is subject to CGT, but the annual exclusion and the 40% inclusion rate will be applied to this, resulting in R224 000 being included in her taxable income.
There are planning opportunities for scenario 3. A residence does not cease to be a primary residence merely because the person is not living there. An absence (provided less than 2 years duration) will not be seen as an absence, if the property had been offered for sale, and vacated due to the acquisition or intended acquisition of a new primary residence. An absence of up to 5 years will also be ignored, if:
a) You reside in the residence for a period of at least one year before AND AFTER the period it was let; AND
b) No other residence was treated as your primary residence during the period of letting; AND
c) You were temporarily absent from the residence due to temporary absence from SA, or were employed or carrying on a business in SA at a location more than 250 kilometres from the residence.
There is also always the case to be made, to motivate your own calculation, especially in times (as we are currently experiencing) of fluctuating market values of immovable property. So I would advise a thorough study of the current market value at the time it ceases to be a primary residence and you embark on the trade of renting out the property. Collect supporting documentation, such as formal valuations, comparative property prices, etc. If such a valuation benefits your calculation in terms of reducing the CGT applicable, then use and motivate it, in your submissions
The onus will be on you, the taxpayer to provide proof of your situation and as always, up front planning and your documentation will be the criteria for success or failure.
Contact Richard for further enquiries on this topic
PROPERTY SALE TAX CONSIDERATIONS
Posted : 15 March 2019
It is unfortunate that people do not always include their “trusted” advisors (read ME) in their financial transactions, whether they are buying a vehicle, or selling immovable property…. So this week I have been working with a client who has sold a property and… as is my way… I have it in for the property agents….
So, Luke, has this property in Hermanus, a really prime property, which is a weekend getaway, but of late, due to work and sporting commitments, he seldom uses it and decided to sell the property. So a few months ago, Luke placed the property with UNS PROPERTIES (short for unscrupulous) to market the property for him. Sure enough they found an interested buyer, showed the property and presented Luke with an Offer to Purchase. All great, Luke happy chappy, Buyer happy and UNS very happy…. This is where he should have consulted with me….
Luke accepted the offer (lets for the exercise here say he did not haggle or negotiate the price), signed the offer, and returned it to UNS. He was happy with the offer and barely read the detailed clauses contained in the 10-page legal document. 2 months later he meets with the attorneys handling the transfer of ownership, and signs all the legal documents and the deal is registered in the deed office some 7 days later. Luke receives his R3 million for the property (this is a fictitious sale because no Hermanus property is so cheap), and hastens to get SARS clearance and Reserve Bank approval to transfer the funds offshore… which is granted and the transfer of the R3 million to the Cayman Islands is effected 3 weeks after the transfer of the property.
It is at this stage that Luke decides to let his accountant know of the wonderful deal he has done and how proud I should be of how he has got his funding offshore. It is also at this stage when I become somewhat worried. There are always implications to transactions, and often these have a tax consequence.
Problem 1: So why I am nailing the agent? Well in reading the offer to purchase / sale agreement / deed of sale whatever you want to call the legally binding document detailing the terms and conditions of the deal, I discovered a little clause stating that the purchase price includes all furniture and fitting in the property. Now there are very specific legal criteria relating to immovable property transfers of ownership. Furniture and fixtures (if needing to be specified in the agreement) would be movable property and these should be in a separate contract of sale or simply invoiced between the parties. UNS should be aware of this, but that would reduce the selling price (on which commission is calculated). Commission saving possible – R28 750. Sorry property agent…
Problem 2: The second problem is of course that transfer duty on the deal (which only applies to immovable property) is overstated. Assuming the property value was R2,5 million and R500 000 for the movables, transfer duty could have been R55 000 less (11% of R500 000).
Problem 3: The horrible capital gains tax. Assuming Luke bought the property for R1 million, 10 years ago, made no improvements to the property, and never lived in the property, then his gain of R2 million would be taxed at an inclusion rate of 40%, meaning that 40% of his gain is added to taxable income (after the annual allowance of R40 000). Further assuming Luke has taxable income (including this gain) to push his marginal rate to the maximum of 45%, then he will be required to pay CGT of R352 800. Again if the movables had been split from the property deal then the gain would have been R1,5 million and the CGT only R262 800…. A R90k saving (justifying my consultation fee…).
Problem 4: Luke had not considered CGT and when told to pay SARS the R352 800 (included in his provisional tax estimate) he retorted: “You have gotta be kidding me…. All my funds are in the Cayman Islands!!! I am not bringing it back so that SARS can have it….”
Some serious consequences which could have been avoided with an hour’s consultation…
Contact Richard for further enquiries on this topic
UNDERSTANDING INCOME TAX – THE TAX CYCLE EXPLAINED
Posted : 15 February 2019
I guess we have all been there – when a professional talks to you and just assumes you know exactly what he / she is speaking about / referring to… A good example is when you are at your doctor, and he / she tells you what is wrong with you and uses long strange medical terminology which are just plain scary, especially knowing he / she is speaking about your body… And of course we all, just nod and “Mmm” or “Aah” and express reactions that really convince them that we understand, but in truth – we don’t. It is perhaps just because most of us have this strange notion instilled, that we must not show any hesitation or a lack of understanding.
And so I come to the conclusion that TAX is much the same, and based on conversations recently with clients, I realise that I sometimes speak to you, and forget that you are not tax specialists. You do not always fully understand the tax cycle we have in SA, which of course brings me back to my old bug bear – why do we not learn about tax in school as a basic life skill? It is something which is going to impact on every learner at some-or-other stage of their lives. So I thought it would be good to write a newsletter on the basics of the tax cycle.
Citizens of a country earn salaries, rentals, investment returns and profits from business for their efforts. It takes money to run a country (and fund our politicians lifestyles – don’t we know it), so the government set up a revenue collection department called SARS to apply the tax laws they have passed. For employees, their income/s are taxed at source through a system called ‘pay-as-you-earn’ (PAYE). Other income earners, whose earnings are not subject to PAYE, pay provisional tax. Provisional tax is like PAYE – it is a collection mechanism. Provisional tax is submitted and paid twice a year on 31 August and again on 28 February. It is based on an estimation for the first six months and again in February for the full year. This is then a credit to your tax obligations for the tax year (March to February each year) as is any PAYE deducted by your employer. NOTE: You can be a provisional taxpayer at the same time as being a PAYE payer (such as if you are employed, but rent out a property – alternative income). If you are a provisional taxpayer then you need to settle your tax obligation by 30 September each year, by virtue of a voluntary 3rd (topping up) provisional tax payment.
THEN, once a year, taxpayers have to submit a return of earning (ROE) - the ITR12 return, which is their actual earnings and deductions for the tax year in question (A tax year is from beginning March to end February – see below). This is your actual final figures and is based on employment records, like IRP5 certificates, and then declarations made by taxpayers, such as the rental or investment income, capital gains, etc. SARS can call for all your supporting documentation to back up your submissions, for example to the rental schedule, such as lease agreements, invoices for costs and even you actual bank statements to see the receipts and payments through your bank. You have to keep these records for 5 years from your latest assessment. This return must be submitted between 1 July and end of October each year (provisional taxpayers have extension until the end of January).
Based on this return (ITR12), SARS will assess the taxpayer (an ITA34). Then based on your submissions, the tax calculation is applied and the tax obligation calculated. If the PAYE and provisional tax you paid, was more than this obligation, according to their tax calculation applied, they refund the overpayment. If too little was paid in PAYE and provisional tax, you have to pay in the shortfall to them.
And lastly (which should possibly have been firstly)... What is a tax year? When we refer to a tax year we are talking about the period: 1 March to 28/29 February of each year. So for example, the 2019 tax year runs form 1 Mar. ‘18 to 28 Feb. ‘19. Not so complex after all… hey? ☺☺