5 Common tax questions regarding investment property
People frequently make decisions regarding property investments without a full understanding of the tax implications involved.
This is according to Jeremy Burman of Private Client Financial Services, a division of Private Client Holdings who says that it is important to understand that if you invest in property with the intention of renting it out, the net rental (less property expenses) will be included in your taxable income and subject to income tax.
“Therefore, the potential tax liability should be taken into account when considering the rental return you expect to receive on the investment. In addition, if you intend to dispose of the property down the line there will be capital gains tax implications that will need to be factored into your decision-making process.”
Burman says that the following tax-related questions often arise with regards to investment property:
1) My cash outflows exceed my inflows on the property – why do I have a tax liability?
“In terms of the Income Tax Act, you will be taxed on your rental income less any expenses directly incurred in earning this income, excluding those of a capital nature. Expenses of a capital nature include the original purchase price of the property, legal fees and transfer duty incurred, improvements made to the property and capital repayments on a loan or bond used to purchase the property. Bond repayments which often constitute the most significant monthly expense incurred in owning property will, therefore, need to be split between the capital repayment of the bond, which is not deductible for tax purposes, and the bond interest, which is deductible.”
“Allowable (non-capital) expenses include ongoing running and maintenance costs such as rates, agent’s commission, cleaning, security, property insurance, repairs and bond or loan interest. When considering whether an expense is a repair (allowable) or an improvement (non-allowable) one must bear in mind that a repair simply restores the asset to its original condition whereas an improvement creates a better asset,” says Burman.
“As such, although the expenses incurred on your property on an annual basis may exceed the amount received in rental income, a taxable rental profit may still arise due to the non-deductibility of certain capital costs such as bond capital repayments and renovations.”
2) This is the only property I own – can I claim the primary residence capital gains exclusion when I sell the property?
Burman advises that in the case of a primary residence, no capital gains tax will arise where the selling price is less than R 2 million. “Where the selling price exceeds R 2 million, the first R 2 million of the gain may be disregarded when calculating a person’s aggregate capital gain for tax purposes. A primary residence, however, is defined as a residence in which a person holds an interest and in which a person ordinarily lives in or lived in as his main residence and uses or used mainly for domestic purposes. Therefore, where a property has been used for a purpose other than the owner’s home this will not be regarded as his primary residence. As such the primary residence capital gains exclusion will not apply where an investment property is disposed of.”
According to Burman, where a property has been used both as a primary residence and as an investment property which was rented out during the course of ownership, the capital gain will need to be apportioned based on the time the property was used for each purpose. “The primary residence exclusion may only be set off against the portion of the gain relating to the primary residence period.”
3) Will I be taxed when I sell my investment property?
“An owner will be liable for tax on the capital gain that arises on the disposal of his investment property,” says Burman. “The capital gain is calculated as the selling price less the base cost. The base cost includes all costs incurred in purchasing the property (e.g. original cost, legal fees, transfer duties etc.), the cost of improvements to the property and the costs of selling the property (e.g. agent’s fees, legal fees). Any costs which have or could have been allowed as a deduction when determining the taxable income e.g. rental expenses such as repairs, bond interest, etc. may not be included in the base cost.”
“Once the capital gain is established the individual will be entitled to deduct the annual exclusion of R 40 000. The inclusion rate of 40% will then be applied to the net gain to determine the taxable capital gain. This amount is included in the individual’s taxable income and taxed at his marginal tax rate. The effective tax rate that will apply to a capital gain will therefore range from a low of 0%, where an individual’s taxable income is below the tax threshold, to a high of 18% (i.e. 40% inclusion rate multiplied by 45 % marginal tax rate), where the individual’s taxable income exceeds R 1.5million per annum.”
4) I co-own my investment property, how do I treat the rental income and capital gain for tax purposes?
Burman advises that where a property is co-owned, whether it be with a spouse, business partner or friend, you will each be liable for tax on your ownership share of the net rental income earned and capital gain on disposal. “Your share of the profit or capital gain will be added to your taxable income and taxed at your marginal rate. This may mean that two co-owners who are in different tax brackets (due to varying amounts of income earned or expenses claimed from other sources) will not pay the same amount of tax on their net earnings from an investment property despite these earnings being equal. It must be noted that each individual owner will be taxed on their ownership share of the total income less total claimable expenses incurred regardless of whose bank account the rental income is paid into and whose bank account the rental expenses are paid out of.”
5) I own property overseas - do I need to declare the rental income I receive on this and the capital gain when I sell this?
“If you are a South African resident then you are required to include your worldwide earnings in your taxable income. So, unless a double taxation agreement exists with the overseas country stating that property rental income will only be taxed in one of the countries, you will pay South African income tax on any income earned from an overseas property less any expenses incurred in earning this income.”
“Equally the taxable capital gain arising on disposal of the property must be included in your taxable income in the year the property is sold. The rand equivalent of the gain can be calculated by applying the spot rate on the date of sale, the SARS’ approved average monthly rate or SARS’ approved annual rate to the foreign gain. If you have paid any foreign tax on either the rental income or the capital gain then you will be entitled to a credit (limited to the South African tax payable on this income or gain) against your South African tax payable.” concludes Burman.
For further advice on property related tax contact Jeremy Burman at Private Client Financial Services on (021) 671 1220.