taxburden_image

 

 

Properties & Income Tax

The first important point to note when reviewing the income tax requirements associated with residential properties is the difference between the tax treatment of primary residences and buy to let residential properties.

In the case of primary residences, the owner of the property lives in the property and there is therefore no income generated from the property. All costs incurred in relation to the property is therefore of a personal nature and cannot be deducted for income tax purposes.

In the case of buy to let properties, the owner leases out the use of the property to an external party and is remunerated in the form of a monthly rental for the use of the property. The rent income will be included in the income tax calculation of the entity in whose name the property is registered - therefore either an individual or a legal entity (for example a company, closed corporation or trust).

All costs incurred in producing the monthly rental income can be deducted for income tax purposes. These costs include property management fees, municipal rates, levies charges by body corporates, repairs & maintenance, insurance, service costs carried by the owner, etc. Proper accounting records therefore need to be kept in order to provide SARS with supporting documents for deductions claimed (when required to do so).

The cost of financing a buy to let property can also be deducted for Income Tax purposes. This means that the interest charged on a bond used to finance a buy to let property can be deducted from income tax.

An important section of the Income Tax Act to be aware of is section 20A which provides for the ring fencing of assessed losses in certain circumstances. An assessed loss will be created from a buy to let property when the total costs (including interest) exceed the income derived from the trade (leasing of property).

This section is only applicable to individuals whose taxable income for a given year of assessment is greater than the level at which the maximum rate of income tax applies (currently R490,000 - 2009 fiscal year). It is basically applied when an assessed loss has resulted from the leasing operation in at least three years during any five year period.

The effect of the ring fencing of the assessed loss will be that the loss is not allowed as a deduction for Income Tax purposes, but carried over to the next year of assessment. The accumulated assessed loss will only be allowed as a deduction against Income Tax once the taxable income form the property exceeds the accumulated loss.

Capital costs like renovations do not directly relate to the operation of the asset and the production of income as these costs generally lead to an improvement in the capital value of the asset and can therefore not be deducted for income tax purposes. Instead, these costs are added to the base cost of the asset in determining the capital gain or loss resulting from the disposal of the property (also therefore applicable to primary residences).

The profit made on the sale of buy to let properties and primary residences do not generally form part of the income tax calculation as these profits are capital in nature. These amounts will mostly be subjected to Capital Gains Tax - click here for more detail on CGT.

The exception would of course be when the residential properties which are sold are in fact bought, not for investment purposes (capital nature) but for trading purposes (as is the case with property developers). The property owner's intention when acquiring a property is therefore an important factor when SARS determines whether a property was acquired for investing (capital) or trading (income) purposes.