One of the most important steps to acquiring property as an asset to generate income, is creating a property portfolio with an experienced professional. These portfolios are often set up as businesses or within a trust. Both of these routes require specific legal standards and often determine the tax you will be liable to pay on these assets.
A famous quote by Benjamin Franklin stated: “in this world, nothing can be said to be certain, except death and taxes”. There will always be tax implications to every decision made when structuring a property portfolio, therefore it is of utmost importance to make sure that there are no tax implications that could result in an unexpected tax liability. When we look at property investment portfolios, there are many ways in which a taxpayer can structure a portfolio in a manner that makes use of the available tax legislation while paying as little tax as possible, if at all. The provisions in the tax legislation can be leveraged to your advantage and lower the tax liability as much as possible, or even delay having to pay tax in a manner which adheres to all relevant tax legislation.
Tax planning therefore incorporates the following action points which are imperative for creating a tax efficient property portfolio:
- Create a tax strategy in order to use the law to your advantage
- Use as many of the deductions and tax incentives as possible
- Use qualified property investment accountants and tax practitioners that work with property investment companies and trusts on a daily basis
- Individuals use after-tax money but property investors operate their business with before-tax money. This means that the property portfolio is taxed on its taxable income, which is derived by reducing the income received with all tax-deductible expenses
- Invest in properties that qualify for tax deductions as stipulated in Section 13sex
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The South African Income Tax Act No. 58 of 1962 (the Act) has always granted general wear-and-tear allowances for movable assets used in a form of trade. It has, however, been selective in granting such allowances for immovable assets such as buildings. Fortunately for investors with residential property portfolios, they have the potential to make use of the significant tax benefit on residential property under Section 13sex of the Act. This incentive allows purchasers of residential units to ‘write-off ’ a percentage of the cost of buildings, or improvements thereof, acquired or built after 21 October 2008.
Taxpayers need to remember that should they dispose of the property, any allowance previously made available will be regarded as recovered or recouped upon disposal. Also, any amount received in excess of the cost of the property will be liable to capital gains tax. With that being said, if the property investor does not plan on selling the property, the advantages of applying the Section 13sex building allowance include:
- The taxpayer’s taxable income reduces drastically, resulting in lower tax
- Cash Flow improves as less taxes are paid over to SARS, resulting in the reduction of shortfalls
- The return on investment of the taxpayer’s property portfolio increases due to the decrease in tax payable
The following criteria applies before a taxpayer can apply the provisions in Section 13sex of the Act:
1. The taxpayer must own at least 5 residential units. A residential unit is defined as a building or self-contained apartment, mainly used for residential accommodation with the exclusion of structures used for business purposes.
2. All units must be situated in South Africa.
3. Residential units must be new and unused. For example, buyers of apartments that had previously been occupied would not qualify for this incentive. It is therefore advisable to purchase the property from a developer to ensure that it meets the criteria.
4. The units must be used solely for the purpose of a trade (i.e. residential letting). This prevents housing claims for personal use.
There are residential allowances for normal residential units, as well as low-cost accommodation residential units that meet the above-mentioned criteria. The latter is very limiting in terms of the value of the property and the amount of rental income that may be generated from the property. Focus will therefore be placed on the available Section 13sex building allowance for normal residential units.
The residential allowance can be calculated as follows:
Step 1: Determine the cost on which the allowance is based
The ‘total cost’ used for the calculation is considered to be the lesser of the actual cost incurred or the market value on the date at which the transaction was concluded. This limitation is in place to prevent taxpayers buying or building a unit at inflated prices from connected parties to obtain a greater tax deduction. Furthermore, there will be no deduction permitted if the taxpayer has previously claimed a deduction under another section of the Act.
Step 2: Determine which percentage of the total cost of the property acquisition price qualifies for the deduction.
Where a new sectional title unit (such as a residential apartment) is acquired, 55% of the acquisition price
30% of the acquisition price where an improvement is acquired.
Step 3: Determine what the annual deduction would be over 20 years
A 5% annual deduction is allowed under the Act for normal residential units. The 5% is multiplied by the portion of the cost calculated in Step 2. This amount will be deductible from the taxable income of the taxpayer for 20 years, if the taxpayer continues to meet the criteria of Section 13sex of the Act for the full period.
An example of the calculation would be as follows:
Total cost price of 5 tenanted residential units in South Africa, owned by the same taxpayer = R5 million
Annual tax write-off: R5 000 000 x 55% x 5%
Equals a deduction of R137 500 per year. This amount is deducted from the taxpayer’s taxable income annually. The effect of this deduction for a company, for example, would be: R137 500 x 28% tax rate = R 38 500 tax saved during a specific tax year
The advantage of the building allowance would be evident for a company that had a Net Profit in its Income Statement of R137 500. The Net Profit is used in the tax calculation, and the Section 13sex amount of R137 500 is deducted from the Net Profit. The taxable income of the company (if there are no other tax adjustments), would be R0. Effectively, for the specific tax year, the company therefore pays over R0 tax to SARS, rather than the R 38 500 it would have paid to SARS based on its net profit of R137 500, had it not qualified for the Section 13sex allowance.
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