Beric Croome on ‘sex’ tax for property investors: Investment insights

 

27 Posted on November 11, 2014 in Property, BIZNEWS.COM

 

If you have plans to build your wealth through residential property, don’t overlook the tax benefits of opting for units in new developments. There’s a significant tax perk that some investors take advantage of as they build their portfolios of rental stock. In a nutshell: if you own five or more residential properties, you can claim an extra tax deduction on units that were acquired directly from a developer. The deduction is contained in a section of the Income Tax Act that is named section 13sex –  which is why property investors joke about this being the sexiest tax deduction ever. Beric Croome, one of South Africa’s most respected tax experts, answers a question for a BizNews visitor who wants to know how the ‘sex’ tax deduction works. – JC

 

 

 

 

 

 

 

 

 

 

By Beric Croome*

 

Dr Beric Croome is one of  South Africa’s most respected tax experts. He explains a tax deduction that helps residential property investors.

The deduction in respect of costs incurred in respect of certain qualifying residential units is contained in section 13sex of the Income Tax Act No. 58 of 1962 (‘the Act’), as amended.

A taxpayer is entitled to an allowance equal to 5% of the cost to the taxpayer of any new and unused residential unit owned by the taxpayer, where that residential unit is used by the taxpayer solely for the purposes of a trade carried on by them and the unit is located within South Africa, and the taxpayer owns at least five residential units within the country which are used by the taxpayer for purposes of a trade carried on by them. Where a taxpayer derives income in the form of rental, that is specifically regarded as the carrying on of a trade as defined in section 1 of the Act.

 

In those cases where a taxpayer acquires low cost residential units, the allowance available is increased from 5% to 10%. The Act defines a low cost residential unit as an apartment qualifying as a residential unit in a building located within South Africa where the cost of that apartment does not exceed R350,000 and the owner thereof does not charge a monthly rental in respect of that apartment which exceeds 1% of the cost thereof. Alternatively, a building qualifying as a residential unit will be treated as a low cost residential unit where the cost of the building does not exceed R300,000 and the owner of the building does not charge a monthly rental in respect of that building which exceeds 1% of the cost of that building, plus a proportionate share of the cost of the land and the bulk infrastructure.

 

From the above, it is apparent that allowance is available only where a taxpayer acquires a new and unused residential unit and that the allowance is not available in respect of pre-existing residential units. Taxpayers need to remember that in the event that they dispose of the property, any allowance previously made available will be regarded as recovered or recouped upon disposal and any amount received in excess of the cost of the property will be liable to capital gains tax.

 

* Dr Beric Croome is tax executive at Edward Nathan Sonnenbergs Inc. He is an advocate as well as a Chartered Accountant (SA). He has 29 years of experience and specialises in the area of tax law, advising clients on taxpayer’s rights, income tax, PAYE and other fiscal statutes  and the tax consequences of foreign investments. He also advises clients on trusts and estate planning. He often represents clients in their dealings with the South African Revenue Service. You can read more of his articles, here on his website, and follow him on Twitter @DrBericCroome

Dr Beric Croome is one of  South Africa’s most respected tax experts. He explains a tax deduction that helps residential property investors.

Extract from SARS website:  http://tools.sars.gov.za/webtools/lnb/sarslegislation.asp?/jilc/kilc/alrg/ulrg/0ds6c/ctw6c 

 

13sex.   Deduction in respect of certain residential units.—(1)  Subject to section 36, there must be allowed to be deducted from the income of 
             a taxpayer an allowance equal to five per cent of the cost to the taxpayer of any new and unused residential unit (or of any new and 
             unused improvement to a residential unit) owned by the taxpayer if--

(a) that unit or improvement is used by the taxpayer solely for the purposes of a trade carried on by the taxpayer;

(b) that unit is situated within the Republic; and

(c) the taxpayer owns at least five residential units within the Republic, which are used by the taxpayer for the purposes of a trade carried on by
     the taxpayer:

     Provided that if a taxpayer completes an improvement as contemplated in section 12N, the expenditure incurred by the taxpayer to
     complete the improvement shall be deemed to be the cost to the taxpayer of any new and unused residential unit (or of any new and
     unused improvement to a residential unit), for the purposes of this section.

(2)  There shall be allowed to be deducted from the income of the taxpayer an additional allowance of five per cent of the cost of a low-cost 
      residential unit of a taxpayer for a year of assessment if deductions are allowable to that taxpayer in respect of that unit in terms
      of subsection (1) during that year of assessment.

(3)  For the purposes of this section, the cost to the taxpayer of a residential unit (or an improvement thereto) shall be deemed to be the lesser
     of the actual cost to the taxpayer or the cost which a person would, if that person had acquired or improved the residential unit under a
     cash transaction concluded at arm’s length on the date on which the transaction for the acquisition of the new and unused residential unit
     (or of the new and unused improvement to the residential unit) was in fact concluded, have incurred in respect of the direct cost of the
     acquisition or erection of the residential unit or improvement.

(4)  Where any residential unit (or an improvement to the residential unit) in respect of which any deduction is claimed in terms of this section
      was during any year of assessment used by the taxpayer for the purpose of any trade carried on by that taxpayer, the receipt and accruals of
      which were not included in the income of that taxpayer during that year, any deduction which could have been allowed in terms of this
      section during that year or any subsequent year in which that residential unit (or an improvement to the residential unit) was used by the
      taxpayer shall for the purposes of this section be deemed to have been allowed during that previous year or those years as if the receipts           and accruals of that trade had been included in the income of that taxpayer.

(5)  No deduction shall be allowed under this section in respect of the cost of any residential unit (or an improvement to a residential unit) that
      has been disposed of by the taxpayer during any previous year of assessment.

(6)  No deduction shall be allowed under this section in respect of the cost of a residential unit (or an improvement to a residential unit) if any
      of the cost has qualified or will qualify for deduction from the taxpayer’s income as a deduction of expenditure or an allowance in respect
      of expenditure under any other section of this Act.

(7)  The deductions which may be allowed or deemed to have been allowed in terms of this section and any other provision of this Act in
      respect of the cost of any residential unit (or any improvement to a residential unit) shall not in the aggregate exceed the amount of such
      cost.

(8)  For the purposes of this section, to the extent that the taxpayer acquires a residential unit (or improvement to a residential unit)
      representing only a part of a building without erecting or constructing that unit or improvement--
      (a) 55 per cent of the acquisition price, in the case of the unit being acquired; and
      (b) 30 per cent of the acquisition price, in the case of the improvement being acquired,

      is deemed to be the cost incurred by that taxpayer in respect of that unit or improvement, as the case may be.

 

Extract from SAICA website  https://www.saica.co.za/integritax/2009/1704_Residential_building_allowances.html

 

Deductions
1704. Residential building allowances
February 2009 – Issue 114In the past, income tax allowances for residential property have had limited application and have not provided any significant relief to taxpayers who purchase residential property for the specific purpose of letting the property.

The Revenue Laws Amendment Act 60, 2008, introduced amendments to, inter alia, sections 13ter and 13sex of the Income Tax Act No. 58 of 1962 (the Act) which consolidate the income tax relief for residential property in an effort to support, in particular, the low-cost housing market.

In terms of the former legislation, a deduction was available for the cost of erecting at least five residential units which formed part of a housing project. In order to qualify for the allowance, the residential units must have been used by a taxpayer for rentals or must have been occupied by the taxpayer’s full-time employees. The deduction was effectively equal to 10% of the cost of the residential unit in the first year in which all five residential units were let or occupied. A further 2% of the cost was deductible in the first year and the succeeding 44 years. The allowance only applied to new residential units which were erected by the taxpayer either directly or under contract with a developer.

In terms of the Revenue Law Amendment Act, this allowance will only be available for residential units, the erection of which commenced before 21 October 2008.

For new residential buildings erected or acquired after 21 October 2008, the provisions of section 13ter are replaced with the provisions of section 13sex.

In addition to the section 13sex allowance there are also specific depreciation allowances for residential property used by employees in the mining industry and residential buildings in Urban Development Zones which will override the section 13sex allowance.

In order to consolidate the allowances for residential property, general definitions for the terms "residential unit" and "low-cost residential unit" have been introduced to the Act.

A "residential unit" is defined as a building or self-contained apartment used mainly for residential accommodation, but excluding buildings or apartments used in a hotel trade.

The definition of a "low-cost residential unit" includes an apartment within a building as well as a stand alone building.

For an apartment within a building, a "low-cost residential unit" is defined as an apartment qualifying as a residential unit in a building located in South Africa where the cost of the apartment does not exceed R250 000 and the owner does not charge a monthly rental in respect of that apartment which exceeds 1% of the cost thereof.

For a stand alone building, a "low-cost residential unit" is defined as a building qualifying as a residential unit located in South Africa where the cost of that building does not exceed R200 000 and the owner does not charge a monthly rental in respect of that building which exceeds 1% of the cost thereof plus the proportionate cost of the land and bulk infrastructure.

The 1% allowable rental for an apartment or a building to qualify as a "low-cost residential unit" is increased by 10% per annum on a cumulative basis.

In terms of section 13sex where the following three conditions are met a taxpayer will be entitled to an annual allowance equal to 5% of the cost of a "residential unit" or 10% of the cost of a "low-cost residential unit":

 

  • the taxpayer erects, acquires or makes an improvement to a new and unused residential unit located in South Africa;

  • the taxpayer uses that unit or improvement solely for the purpose of a trade; and

  • the taxpayer owns at least five residential units within South Africa which are used by the taxpayer for the purposes of a trade carried or by the taxpayer.

  • It is worth noting that the letting of property is specifically included in the Act’s definition of a trade. Therefore a taxpayer which acquires residential units for the purpose of letting those units will carry on a trade and may qualify for the 5% or 10% allowances if the above conditions are met.Even though the section 13sex allowance is greater than the historic allowances, it is submitted that the application of the allowances is still limited in the buy-to-let market. This is mainly because the allowance is still limited to new and unused units or improvements thereto. The cost of second-hand residential units purchased by a lessor as part of his letting trade will still not qualify for any allowance under the Act.Edward Nathan SonnenbergsIT Act:S 1 definition of "low-cost residential property", "residential unit"IT Act:S 13terIT Act:S 13sex

EXTRACT FROM THE SOUTH AFRICAN INSTITUTE OF TAX PROFESSIONALS

http://www.thesait.org.za/news/167206/FAQ---3-April-2014.htm

3. Income Tax – Section 13sex allowance for residential units

Q: If a person bought 5 five new properties (flats in a flat block) from a developer at R500 000 per property and all five properties were rented out in the 2014 financial year how can we use section 13 sex of the Income Tax Act in this scenario? Secondly, say the one property have a tenant in one month before the transfer goes through to the new owner can we then still use section 13 sex in this scenario or how will SARS see it?

A: Sec 13sex(1) of the Income Tax Act (No. 58 of 1962) (hereinafter referred to as ‘the Act’) provides an allowance for the following:

‘... Subject to section 36, there must be allowed to be deducted from the income of a taxpayer an allowance equal tofive per cent of the cost to the taxpayer of any new and unused residential unit (or of any new and unused improvement to a residential unit) owned by the taxpayer if—

(a) that unit or improvement is used by the taxpayer solely for the purposes of a trade carried on by the taxpayer;

(b) that unit is situated within the Republic; and

(c) the taxpayer owns at least five residential units within the Republic, which are used by the taxpayer for the purposes of a trade carried on by the taxpayer ...’ (own emphasis added).

A ‘residential unit’ is defined in sec 1 of the Act as follow:

 

‘... means a building or self-contained apartment mainly used for residential accommodation, unless the building or apartment is used by a person in carrying on a trade as an hotel keeper.’

Sec 13sex(3) determines what constitutes the ‘cost’ of a ‘residential unit’. It holds that the cost is deemed to be the lesser of:

‘... the actual cost to the taxpayer or the cost which a person would, if that person had acquired or improved the residential unit under a cash transaction concluded at arm’s length on the date on which the transaction for the acquisition of the new and unused residential unit (or of the new and unused improvement to the residential unit) was in fact concluded, have incurred in respect of the direct cost of the acquisition or erection of the residential unit or improvement.’

Therefore in terms of sec 13sex(3), the ‘cost’ of the unit is deemed to be the lesser of the actual costs incurred or the market value on the date on which the transaction was concluded. However, sec 13sex(8) states the following regarding what the ‘costs’ are for residential units not constructed by the taxpayer:

‘(8)  For the purposes of this section, to the extent that the taxpayer acquires a residential unit (or improvement to a residential unit) representing only a part of a building without erecting or constructing that unit or improvement—

(a) 55 per cent of the acquisition price, in the case of the unit being acquired; and

(b) 30 per cent of the acquisition price, in the case of the improvement being acquired,

is deemed to be the cost incurred by that taxpayer in respect of that unit or improvement, as the case may be.

Therefore the cost of the flats for purposes of sec 13 sex will have to be 55 per cent of the acquisition price. Given the fact the cost per unit is more than R350 000, the apartments won’t qualify as ‘low-cost residential units’ as defined in sec 1 of the Act (in terms of par (a) of the said definition) and would consequently not qualify for the additional five per cent allowance in terms of sec 13sex(2).

 

The fact that the one unit was occupied before transfer of ownership to the taxpayer

The fact that one of the units was occupied before the taxpayer received ownership thereof will cause the taxpayer not to have five ‘new and unused’ residential units. However, upon proper construction of the words in sec 13sex(1) it would appear that the four units that are in fact new and unused would qualify for the allowance. This is caused by the fact that subsec 1 of sec 13sex refers to a specific residential unit that needs to be ‘new and unused’ whilst par (a) and (b) of the said section refers to the requirements of that specific unit i.e. it must be used solely for trade purposes and must be situated within the Republic. The distinguishing factor comes in at par (c) of sec 13sex(1) which requires that the taxpayer owns at least five residential units within the Republic used for trade purposes. Note that in par(c) no distinction is made between ‘new and unused’ residential units and ‘used’ residential units. It should further be noted that no distinction is made in the definition of ‘residential unit’ in sec 1 of the Act as to whether a ‘residential unit’ should be ‘new and unused’. It is therefore submitted that the requirements of sec 13sex(1) are met and that the four units that are ‘new and unused’ may qualify for the allowance in terms of sec 13sex(1) subject to restrictions and requirements imposed in the rest of sec 13sex.

Conclusion

From the facts provided, it would seem as if the sec 13sex allowance may be granted on the four ‘new and unused’ units. The unit that was occupied before the transfer of ownership thereof to the taxpayer would not qualify as it is not ‘new and unused’. The allowance will be equal to 5 per cent which must be calculated on the ‘cost’ of a residential unit which would be determined in terms of sec 13sex(8) in your particular case (due to apartments being acquired).

 

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