We recently put out a Newsflash dealing with the right of property owners in single residential zones to build an additional dwelling on their property. This Newsflash has elicited quite a response and we have received numerous questions about the tax implications of exercising the right, either by way of subdividing (if allowed) or by way of Sectional Title. If you haven’t read our earlier Newsflash we recommend that you do so before reading this one, as without it some of the content hereof might not be particularly clear. Our prior Newslash can be found at: 2nd Dwelling Restrictions
Here are some of the questions which we received along with our reply:
- If I exercise my right by building a second dwelling and I sell it immediately as a sectional title unit for a profit what will the tax consequences be for me?
- Answer – Income tax is applied to all profit made in the process of a deliberate business activity even if it is a once-off activity. When you do this, you are no different from a traditional developer who also pays income tax on the profits made from the sale of properties he has built. SARS will assess your profit as being the result of a business activity and the profit will be added to all your other taxable income and subjected to income tax. Personal income tax for individuals tops out at 45% once you earn more than R1.5 million per annum.
- Would it be different if I didn’t apply the sectional title solution and managed to rather obtain the right to subdivide and then built and sold?
- The answer would be the same
- If I exercise my rights by converting my existing dwelling ownership into sectional title, reserve to myself the right to build an additional dwelling and then sell that right immediately what will the tax consequences be for me?
- Answer – The consequences will be exactly the same as in question one above. SARS will conclude that you made all these changes with the view to making a quick business profit and will add it to your existing taxable income and subject it to income tax.
- What if I implemented the steps set out in question three above but didn’t sell the right to build the additional dwelling immediately and kept it as a long-term investment hoping that it would become more valuable as time goes by .
- Answer – Once again the consequences will be exactly the same as per questions 1 – 3. The fact that you do not intend to sell it immediately and make an immediate profit does not detract from the fact that you implemented this solution with the view to selling the right and making a profit. The profit (when it is finally realised) will be subjected to income tax.
- What if I exercise my right by building a second dwelling as contemplated in paragraph 1 or 2 above and then decide to keep it as an investment and lease it out on a monthly basis to make a rental return on my investment ?
- Answer – You will pay income tax on the profit which you make from your rental enterprise. In other words, after deducting from the rental any costs of ownership of the 2nd dwelling such as maintenance, the interest included in any bond payment, rates and taxes and insurance et cetera the balance will be profit subjected to income tax.
- What if after a while as per my question 5 above I decide that I no longer want to be bothered with tenancies and rental collection and the like and sell the 2nd dwelling that I built and make a profit on the sale?
- Answer – That profit will not be subjected to income tax. There is another tax waiting for that profit namely capital gains tax. That is fortunately a much lower tax than income tax. Capital gain tax is applied to the profit which is made when you sell an asset which you never acquired initially for purposes of resale.
- The classical example is if I buy a fruit tree with the intention to sell the tree I will pay income tax. If I buy the fruit tree with the intention to sell the fruit I will pay income tax on the fruit sales. If I decide to get out of the business of selling fruit and then sell the tree I will pay capital gains tax on the gain I make when selling the tree.
- The determination of which tax applies depends on the state of mind of the taxpayer. Having said this SARS will be extremely suspicious if you maintain your rental business for only a month or two and then sell. In such circumstances SARS will suspect that it was your intention when you built the second dwelling to sell it for a profit and your profit will be subjected to income tax. The calculation of the capital gain tax which you will have to pay is quite complex but as a rule of thumb for human beings you will pay a maximum of 18% of the total profit/gain as tax, (and then only if you already earn more than R1.5million a year).
- In determining your profit/gain you will deduct from the sale price of the second dwelling the costs of constructing it and of course the costs of establishing the sectional title structure and estate agents commission.
- What if along the way in any of the circumstances stated in the questions above I decide to sell my original home?
- Answer – You will not pay income tax and will only pay Capital Gains tax on any amount that exceeds R 2 million net gain. (i.e. the first R2million net gain is exempt from CGT on a primary dwelling). The net gain will be calculated in the same way as above.
- NB – If capital gains tax is payable then, along with your other usual income tax, it is payable at the end of the financial year in which the sale occurred (not date of transfer!)
Lastly, there Is a special rule applicable to non-residents. As SARS is afraid that non-residents will take their profits and leave the RSA, conveyancers are obliged (if the sale price is R2 million or more on any sale of immovable property) to retain a portion of the purchase price of the property on transfer (it ranges from between 7.5% for individuals; 10% for companies and 15% for Trusts). The seller is then required to go to SARS and to calculate the correct amount of capital gains tax to be paid and to obtain a written ruling.The conveyancers will then pay that to SARS and pay the rest (if any) to the seller. The effect of this on non-residents is that they have to pay the capital gains tax immediately.
If you wish to read up more on the topic of CGT v income tax, visit this hyperlink: http://www.dejure.up.ac.za/index.php/en/volumes/45-vol-1-2012/82-notes2.html. The bottom line is that a proper financial analysis with a tax expert is advised, before you embark on this journey. Either way though, if you end up paying more tax, it means you are making more money – The question you ought to ask yourself is which structure will result in the least amount of tax!
Milton Koumbatis (Consultant); Robert Krautkramer (Director)
Miltons Matsemela Inc