Benjamin Franklin wrote in a 1789 letter that “Our new Constitution is now established, and has an appearance that promises permanency; but in this world nothing can be said to be certain, except death and taxes.”
Many investors in South Africa prefer to invest in real estate for capital growth and passive income from rentals in order to provide a comfortable standard of living in retirement. These investors, however, generally purchase the properties in their personal capacity, which means that this increases their gross estate at death.
According to a Fin24 article published in February 2013 entitled “The real costs of death“, more than 30% of South Africans do not have sufficient capital in their estate at death to cover the costs. This results in assets in a deceased estate having to be disposed of in order to raise the required capital.
Having a property portfolio means that property in your estate may have to be sold, which triggers capital gains tax in addition to other estate costs.
In the 2018 budget speech, one of the highlights that must be taken into consideration is that the estate duty has been increased to 25% for a dutiable estate of R30 million or higher. This was a proposal in the Second Davis Tax Committee report, which is now being implemented.
In addition, the Value Added Tax (VAT) rate will increase one percentage point from 14% to 15% from 1 April 2018, which, on a large estate, can have a significant impact.
These are the following costs that must be taken into consideration when estate planning.
This is the fee that is payable to an executor appointed to wind up the deceased estate. The fee is negotiable depending on the size of the estate but is charged on the gross value of the estate which includes cash, investments, properties, vehicles, furniture and other life policies (which are deemed property).
At present, the fee is 3.5% (excl VAT) and up to 6% (excl VAT) for any income generated monthly in the deceased estate such as interest from an investment portfolio or rental income.
When the increase in VAT comes into effect, this will up the executor fee to 4.03% and 6.90% respectively. The 4.03% is charged upfront and the 6.90% is charged monthly if income is generated in the deceased estate.
If a property is bequeathed to a beneficiary in a deceased estate, the property has to be transferred into the name of the new owner through the deeds office.
This means a conveyancing attorney, such as STBB (Smith Tabata Buchanan Boyes), has to be appointed to assist in the transfer, which comes at a fee.
The transfer cost will depend on the property value which is being transferred. To get an idea of the fee, you can input your property values and receive a quotation using this transfer cost calculator. (Note that the fee may vary between law firms, but are based on the Law Society’s recommended tariffs.) The more properties that have to be transferred, the greater the fees that will be charged. There must be provisions in the estate to cover these expenses.
Transfer duty is levied on the value of a property above R900 000. This tax is calculated on the value of the property and not the price, and is payable to SARS when a property is transferred from the seller’s name into the buyer’s name.
Below is a table of the transfer duty tax rates for the 2018/ 2019 financial year:
If there are multiple properties in a deceased estate exceeding R900 000 in value, then these taxes can start to accumulate, resulting properties having to be sold.
There are transfer duty exemptions, but the above is the typical tax payable.
Capital gains tax
This is a tax that is triggered when an asset is disposed of, transferred or sold. Natural persons have a R40 000 per year capital gains tax (CGT) exemption per annum and this increases to R300 000 in their year of death. For a primary residence, there is a capital gains tax exemption of R2 million for natural persons.
Any capital gain above these exemptions is taxed with an inclusion rate of 40% against their marginal rate of tax, meaning 40% x a person’s marginal rate of tax. The maximum CGT rate is 18%, based on the highest marginal tax rate of 45% for income earners of R1.5 million or higher per annum. [0.4 x 45% = 18%] This CGT is added to their tax submissions and is payable to SARS.
Estate duty is payable on the estate of every person who dies, whose nett estate is in excess of R3.5 million. It is charged at the rate of 20%. If the nett estate exceeds R30 million, the estate duty charged is 25%.
With multiple properties in a deceased estate, which are estate dutiable, this can lead to high costs in settling the expenses before an estate is wound up. The executor may have to sell properties to free up capital, which results in CGT and also a loss of rental income to beneficiaries of the estate.
If you add up all the potential expenses in the estate:
- Executor fee: 4.03% (based on full executor fee including VAT)
- Capital gains tax: 18% (based on highest marginal rate of tax)
- Estate duty: 20% (based on a dutiable estate less than R30 million)
Total: 42% of the estate may be depleted to cover these fees and taxes
Life cover can be taken out to cover the executor fees and estate duty costs, but this excludes transfer cost and transfer duty of any property in the estate. And then there is the added cost of maintaining the life policy depending on the premium pattern.
If there is a Testamentary Trust to be formed as per the last will and testament, then the amount that is transferred or residue will be significantly depleted.
How to avoid the above estate costs and taxes:
As a Certified Financial Planner®, I believe that prevention is better than cure. A life policy is a cure, however, it could be prevented all together as it is taken out to cover fees and taxes.
When setting up a property portfolio, the owner of the property, should ideally not be a natural person. This is to prevent the above-mentioned fees and taxes having to be paid at death.
Instead, an inter vivos (living) trust is registered whilst the property investor is alive and they become a founder and trustee.
The trust owns the assets and acts like a vault. These assets therefore do not form part of your estate, preventing those costs and taxes.
However, in terms of generating an income in the trust, we prefer to utilise a company as this would have a flat tax rate of 28%. A trust has a flat tax rate of 45% which has the benefit of income-splitting through the conduit pipeline principal where proceeds of a trust can be split to the beneficiary at their marginal rate of tax. This benefit is under review by the Davis Tax Committee and may fall away due to the lower taxation on income which could be taxed directly in a trust.
The company shareholding is held 100% by the trust and the properties are purchased in the name of the company. As the shares of the company are held by the trust, the shareholding does not form part of the estate of the director or directors.
Instead of purchasing the properties in the name of a natural person, the properties are purchased in the name of a newly formed company, and the shares of this company are held by the inter vivos discretionary trust. The trust protects the assets of the company so that the shareholding does not form part of the estate of the investor and the company generates the revenue where the profits are taxed at a flat rate of 28%.
This creates a hybrid model by utilising both the trust and company in order to create a tax-efficient investment vehicle. It protects assets from creditors as well as estate costs at death. By structuring a property portfolio in this manner, an investor is effectively duplicating the benefits of Section 37C of the Pension Funds Act, which refers to the death benefits not forming part of the deceased estate of the member of a retirement fund. Trustees are appointed to distribute proceeds to nominated beneficiaries at their discretion.
Recommended property portfolio structure:
Please feel free to comment on this article. If you would like to schedule a free consultation to discuss your property portfolio, please contact one of our offices so a Trust Attorney representing Trust Focus (Pty) Ltd can provide expert advice. You can email firstname.lastname@example.org or call:
Cape Town: 021 979 2501
Pretoria: 012 943 0201
Durban: 031 110 0817