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Safe (from tax) as Houses

25 July 2017   (0 Comments)
Posted by: Author: Candice Mullins
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Author: Candice Mullins (admin@thetaxhouse.co.za)

A look at the key questions related to the circumstances that will exempt you from capital gains tax on the sale of a house. 

Selling your house can be a complicated, stressful task. Thankfully, you will often be exempt from paying capital gains tax (CGT) on your primary residence.

 

CGT is usually paid on assets that you own which grow in value. However, when your primary residence is sold for R2 million or less, or if the capital gain that you make from the sale is R2 million or less, you will not have to pay any CGT on the sale. Even if you do sell your house for a capital gain that exceeds R2 million, the exemption benefits you. In this instance, when calculating how much CGT you would pay, the sale price will be reduced by R2 million.

 

Let us look at how this works. Let us assume that your home grows in value by 10% per annum. Thus, if you paid R1 million for your home, you will probably sell it for R2.6 million 10 years later (assuming you have not made any improvements). Your capital gain will be R1.6 million (i.e., R2.6 million minus R1 million). Because R1.6 million is under the threshold of R2 million, no CGT will apply.

 

There may be a time when the capital gain from the sale of your home exceeds the tax-free threshold of R2 million. So, if we take the above example but this time the home grows by a value of 12%, then your capital gain becomes R2.1 million (i.e., R3.1 million minus R1 million). This means that CGT will be paid on only R100 000 or R2.1 million less the exemption of R2 million. The maximum CGT that an individual would pay on this gain is R18 000 (R100 000 x 18%).

 

What is a primary residence?

 

To take advantage of the exclusion, the residence being sold has to fit within the definition of a “primary residence”.

 

Paragraph 44 of the Eighth Schedule to the Income Tax Act describes a primary residence as a structure (this can include a boat, caravan or mobile home). An empty plot would not fall within this definition.

 

Also, the person who has the interest in the residence must be:

  • A natural person; or
  • A beneficiary of the special trust (this is a type of trust set up for persons with disabilities who are  unable to take care of their own financial affairs or a testamentary trust where the youngest beneficiary is still a minor); or
  • A spouse of that person or beneficiary.

And, the person must:

  • Ordinarily reside in the residence as his or her “main” residence; and
  • Use the residence “mainly for domestic purposes” or their ordinary residence.

A holiday home would thus not fit within the definition of a primary residence.

 

An interest in a residence includes a real right, such as a long lease in excess of 10 years, or a right of use or occupation. An interest in a share block company is considered a real right and the sale of shares in a share block company could take advantage of the primary residence exclusion if the other criteria are also met.

 

According to case law, “mainly for domestic purposes” means that more than half of the measured floored area must be used for domestic purposes.

 

Also, there may be reasons for a taxpayer to be absent from their primary residence for work or vacation. This does not necessarily disqualify their home from being a primary residence for the purpose of the exclusion. However, each case will be judged on its own set of facts and circumstances.

 

Furthermore, the intention of the taxpayer is vital and, although “ordinarily resident” and “ordinarily reside” are not technically the same term for tax purposes, the principles are the same and can, therefore, make a persuasive argument. South Africa uses the principle in the absence of other court interpretations of “ordinarily reside”.

 

The court found the definition of “ordinarily resident” to mean a place where the person considers it to be his or her true home or a place where he or she returns to from their wanderings.

 

What about the land?

 

The land on which the primary residence is situated does form part of the primary residence as long as it is used mainly for domestic or private purposes, together with the residence.

 

The land considered for domestic purposes is, however, limited to two hectares. If the land exceeds two hectares, the gain will have to be apportioned between the non-domestic component and the primary residence component. This is common in situations where a small holding or farm is sold with a homestead on it. When selling such a type of property, it is extremely important to ensure that the wording on the sale agreement allocates a specific value to the homestead component of the selling price.

 

To qualify for the primary residence exclusion on the land component, both the land and the residence situated on it must be sold at the same time and to the same person.

 

How many primary residences can you have at a time?

 

The primary residence exclusion may only be claimed for one residence at a time (see paragraph 45(3) of the Eighth Schedule of the Income Tax Act). Thus, in a case where a taxpayer commutes for work from Johannesburg to Cape Town and his or her family lives in Cape Town, while he or she has

a residence in both cities, he or she will have to choose which of the two residences will be his or her primary residence. It cannot be both.

 

Another similar consideration is where, in terms of customary law, a person may have four spouses who all reside in different residences. In such instances, the taxpayer will also have to choose which of the residences is the primary residence.

 

The exception to the rule

There are exceptions where you may qualify to hold two primary residences at the same time (see paragraph 48 of the Eighth Schedule of the Income Tax Act). The exceptions are as follows:

  • If you are building a new home, while still residing in another home
  • If you are trying to sell your previous home, while residing in a new primary residence or intending to reside in a new primary residence
  • The residence has become inhabitable due to fire, flood or another similar reason and you have had to temporarily reside somewhere else

In the above situations, to continue to qualify as a primary residence, the period that you did not ordinarily reside in the primary residence is limited to two years.

 

What about a house that belonged to a deceased person?

 

A deceased estate can deduct the primary residence exclusion.

 

What if you have used your residence partly for trade purposes?

 

It is common for individuals to use a part of their home for trade purposes. If home office expenses are claimed on your ITR12, you fall within this category.

 

The implications of such instances are that, when the residence is sold, the primary residence exclusion would be reduced on a pro rata basis. The most common basis of calculating this is by using the floor-area method.

 

For example, suppose your home is 400 m2 and 50 m2 of the home is used for trade purposes. Upon selling the property, the primary residence exclusion would be reduced by 12.5% (50 m2 ÷ 400 m2).

 

What about joint estates?

 

If you are married in community of property and the primary residence falls within your joint estate, the net selling proceeds, tax base and primary residence exclusion must be split evenly between the two spouses. In this way, each spouse will receive a R1 million benefit.

 

What are the consequences of letting out your residence?

 

Paragraph 50 of the Eighth Schedule of the Income Tax Act states that a residence can be let out for a period of no more than five years, while still being considered a primary residence, if either the taxpayer, his or her spouse or the beneficiary of a special trust has resided at the residence in question for at least one year before and one year after the period of absence. You will not qualify if you had another primary residence during your absence, nor if your temporary absence was at a location closer than 250 km from the residence, unless it was outside the Republic of South Africa.

 

The primary residence exclusion will be reduced by the percentage of time that the residence was let out. So, if you owned the primary residence for 10 years, of which it was let out for three years, the primary residence exclusion will reduce from R2 million to R1.4 million.

 

What records should you keep?

 

It is important to maintain the following records so that the lowest possible CGT on the sale of your residence can be determined:

  • Original conveyancing documents, proving original purchase price and transfer costs
  • Proof of expenses in relation to any improvements effected on your primary residence (remember, repairs cannot be included in the tax base)
  • The valuation certificate proving the market value of your residence on 1 October 2001 (this is when CGT was brought into our tax legislation; therefore, no CGT is payable for the period before this date and for homes purchased after this date, the 1 October 2001 becomes superfluous)

There are three possible methods of determining CGT (i.e., the market value, 20% of the proceeds and the time apportionment basis). The information provided in this article will assist you in determining which will be the most tax efficient method for you.

 

Please click here to complete the quiz.

 

This article first appeared on the July/August 2017 edition on Tax Talk. 


 

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