TAX IMPLICATIONS OF SELLING YOUR PRIMARY RESIDENCE
The decision to sell your home is a big one, and generally involves both emotional and financial factors.
Often it coincides with a change in circumstances – such as a new job requiring relocation, a baby on the way, or perhaps children leaving the nest. The reasons for selling your home are many and varied – nonetheless it is important to consider the tax implications so you are prepared for any potential liability that may arise.
Jeremy Burman of Private Client Holdings says tax on capital gains was introduced with effect from 1 October 2001 and applies, subject to certain exclusions, to gains made on the disposal of capital assets from this date.
“Although we often hear of the term ‘capital gains tax’, this is a misnomer as no separate tax applies to capital gains, rather a portion of the gain (40% in the case of individuals) is included in your taxable income and subject to income tax according to the sliding scale along with your other earnings for the tax year,” says Burman.
“The effective tax rate payable on a capital gain is dependent on the income tax bracket into which you fall and can range from 0% for individuals under the tax threshold to 18% for those who have income in excess of R1.5 million (40% of the gain x 45% marginal tax rate).”
How it is calculated
According to Burman, a capital gain for tax purposes is calculated as the difference between the proceeds i.e. the selling price and the base cost. The base cost of a property would include all costs of acquiring the property (purchase price, transfer duty, legal costs etc.), the cost of capital improvements to the property (these will exclude the costs of maintaining the property) and selling costs such as advertising or agent’s commission.
Since only the gain after 1 October 2001 is taxable, the portion of the gain that relates to the period prior to this date (for properties acquired before this date) is excluded. This is calculated by using either the market value as at 1 October 2001 or an amount determined in terms of a time-based formula, he says.
R2 million exclusion on your primary residence
“Certain exclusions within the Income Tax Act provide for some tax relief when it comes to the disposal of a primary residence by a natural person,” says Burman.
“Where the selling price of the property is less than R2 million the entire capital gain or loss must be excluded for tax purposes. The Act also provides that the first R2 million of a capital gain or loss on disposal of a primary residence must be disregarded. Where a property is jointly held, such as in the case of a married couple, the gain as well as the R2 million exclusion must be ‘shared’ equally by the owners.”
Burman shares an example for this:
If Mr and Mrs Smith dispose of their house with a base cost of R3 million for a selling price of R5.5 million, their capital gain will be equal to R 2.5 million. After deducting the joint R2 million exclusion they will be left with a net gain of R500 000. They will each then include R250 000 of this gain in their return.
Individual taxpayers are also currently entitled to an annual general capital gain exclusion of R40 000 on top of the primary residence exclusion, thus potentially bringing each portion of the final net gain down to R210 000.
Therefore Mr and Mrs Smith would then each have R84 000 (40% x R 210 000) included in their taxable income. If Mr Smith is in the 26% tax bracket and Mrs Smith in the 41% tax bracket, the tax payable on their capital gain would be R 21 840 and R 34 440 respectively. In this case their combined tax works out to be about 1% of the selling price as the primary residence exclusion and the inclusion rate assist in keeping the effective tax on the disposal relatively low.
Secondary properties and capital gains
“It is important for homeowners to bear in mind that only one house may be regarded as a primary residence at any one time. Therefore if the property disposed of by the Smiths was their weekend holiday home, SARS would not regard this as their primary residence and they would be unable to claim the R2 million exclusion,” says Burman.
“They would each, therefore, declare a net gain of R1.24 million (R2.5m x 50% less R40 000 annual exclusion each), which would result in R496 000 being included in their taxable income. Their tax liabilities from the disposal would increase substantially to a minimum of R128 960 and R203 360 respectively, possibly more as this additional income could push them into a higher tax bracket – resulting in a combined tax equal to at least 9.5% of the selling price.”
Home-based businesses and capital gains
Furthermore, Burman says if a homeowner carried on a profitable business from the property and has claimed a portion of household expenses against his income earned in this regard, then the gain from the property must be split between the portion that relates to the business and the portion that relates to the primary residence.
“Only the latter may be offset by the R2 million primary residence exclusion. For example: Susie has set up a room in her home from which to run her consulting business. This room comprises 15% of the floor space of the house. She sells this property and makes a capital gain of R 1.5 million. Ordinarily, if she had not carried on a business from her home, there would be no tax implications on this disposal as the gain falls below the R2 million exclusion,” says Burman.
“However, in this case she will be taxed on the portion that relates to her business, therefore she will need to declare a capital gain of R225 000 (15% of R 1.5 million). From this she can deduct the annual exclusion to arrive at a net gain of R 185 000. This will result in an amount of R74 000 being included in her taxable income to be taxed at her marginal rate.”
Burman says the above scenario should not discourage a homeowner from deducting home office expenses when they carry on a business from home as the tax savings to be gained from the deductions over the years will usually exceed any capital gains tax liability that will arise in the future.
Owning your house through a trust
A common question is whether it makes sense for your company or your family trust to be the owner of your home. This is a very complex area of legislation that is currently under review and is in a state of flux. Burman recommends you consult an expert who is up to date with regards to changes.
Currently, says Burman, although there may be reasons other than tax considerations why owning your house through a trust may be appropriate in certain circumstances, it is not generally a tax efficient solution from a capital gains perspective, for two reasons: Firstly, the primary residence exclusion is only available to natural persons and not to companies or trusts; secondly, the lower inclusion rate for natural persons (40%) compared to that for trusts and companies (80%), means that in all cases the effective tax rate on capital gains will be lowest in the hands of an individual.
The importance of keeping records
“With the general growth in house prices over time, it is likely that a capital gain rather than a loss will be generated when disposing of a property that has been held for a number of years. In order to minimise this gain and the resultant tax, it is important for homeowners to keep a record of the cost of all renovations and improvements incurred on the property over the years so these can be included in the base cost when the property is eventually disposed of,” says Burman.
“It is also worthwhile consulting your tax adviser when considering a move to establish any potential tax liability that may need to be factored into your decision.”
HOUSE PRICES SLOW AS ECONOMIC STAGNATION BITES
The FNB House Price Index inflation rate for August 2015 slowed mildly further, continuing a broad price growth slowdown that began in early 2014
“The further slowing is hardly surprising, coming on the back of ongoing economic stagnation with a rising risk of recession, and gradually rising interest rates,” says household and property sector strategist at FNB Home Loans, John Loos.
The FNB House Price Index for August 2015 rose by 4.9% year-on-year, down from the revised 5.2% for July, continuing the broader slowing price inflation trend that started in early 2014, where house price growth had hit a multi-year high of 8.6% at the end of 2013.
In real terms, when adjusting for CPI inflation, the rate of house price growth had slowed to 0.3% year-on-year in July (August CPI data not yet available), with rising CPI inflation of 5% only marginally lower than July house price inflation, says Loos. “It is likely that the real house price rate of change in August will come in at zero or even negative, given slowing house price inflation and rising CPI inflatiThe average price of homes transacted in August was R1 002 665, according to the report. on.”
Until recently, the key drivers of the broad year-and-a-half slowing house price growth trend have emanated from the demand side of residential property, but more recently we may have seen signs that supply side factors are also just be beginning to play a role,” says Loos.
Secondly, the economy continues its broad multi-year stagnation, causing GDP growth to slow, from a post-recession high of 3.2% in 2011, to 1.5% in 2014, and the indications are that 2015 may be even slower, he says. “This has slowed employment and wage bill growth; 2nd quarter 2015 GDP numbers were particularly bad, showing 1.2% year-on-year growth while contracting by -1.3% on a quarter-on-quarter annualised basis.”
Thirdly, he points to recent quarters having seen a dramatic drop in consumer confidence levels. The FNB-BER Consumer Confidence Index dropped to a negative level of -15, the lowest level in 15 years. “This may not only be a function of a deteriorating economy, but also be driven by concerns over the longer term future of South Africa, given a raft of bad news relating to economic management and the conditions of state-owned enterprises, especially in the area of electricity supply.”
On the supply-side, Loos says an acceleration in growth in residential buildings completed, to 31.9% year-on-year in the 2nd quarter, has the “potential to begin to alleviate residential supply constraints in certain areas” where they exist, should positive growth be sustained through the second half of the year.
He says looking at the longer term real house price trend (house prices adjusted for CPI inflation), it is evident that despite some rise in recent years (+3.5% since the October 2011 low), the average real house price level remains -19.6% below the high reached in December 2007 at the back-end of the residential boom period.
Going further back, the average real price remains 64.2% above the January 2001 level, just before boom-time price inflation started to accelerate rapidly, he says.
“Real house price levels thus remain at ‘boom-time’ levels in our view, despite having lost some ground since the end of 2007,” says Loos. “In nominal terms, when not adjusting for CPI inflation, the average house price in July 2015 was 272.5% above the January 2001 level.”
In terms of the outlook, Loos says the worse than expected 2nd quarter GDP figure, an alarming drop in the 2nd quarter FNB-BER Consumer Confidence Index, and recently a sharp month-on-month decline in the FNB Valuers Residential Demand Rating, suggests that “a recession has become a distinct possibility”.
“Our most recent average house price growth forecast is 5.4% for 2015 as a whole, slowing to 4.2% in 2016,” says Loos.
However, he notes those forecasts are based on low positive economic growth continuing in South Africa during 2015/2016. “This is an increasingly hazardous assumption to make as China’s economic cracks widen, and SA’s own structural constraints get seemingly worse.”
Thus, Loos says the house price forecast risks lie very much to the downside of the recent forecast. “In a China ‘hard landing’ scenario, and a resultant domestic recession, the risk of house price deflation becomes very possible.”
V&A SET TO BECOME CAPE ECONOMIC POWERHOUSE
Large-scale developments at the V&A Waterfront are having a strongly
discernible impact on the national economy. Globally ranked as a unique geographic destination, the Waterfront is providing investors and businesses with the sought-after combination of live, work, and play.
An economic impact study completed by the City of Cape Town in the first half of 2014 showed a cascade of benefits from new properties, and facility upgrades extend beyond the city to influence the province’s and the country’s performance. Approximately R198 billion was contributed to the national economy by the V&A from 2002 to 2014, with the Western Cape’s gross economic output buoyed by R29.3 billion last year alone. New developments are projected to raise nominal GDP by a cumulative R188 billion by 2023, with the V&A as a whole expected to generate R220 billionover the next decade.
As part of the research into the drivers of this economic potential, tallies have demonstrated 26% of total tourist time spent in the Western Cape is accounted for by the historic landmark. 23.1 million visitors were drawn to the destination last year, up from 21.5 million in 2012. This growth trend is forecast to continue for the next decade.
The V&A has spent hundreds of millions implementing the expansion of the Victoria Wharf shopping centre and its surrounding precinct. This has led to double-digit retail sales growth for the fourth consecutive year – an effective 19% annually. The Waterfront has opted for retail space densification to accommodate the growing demand from local and international retailers: internal refurbishment projects designed to increase the gross lettable area have successfully stimulated commercial traffic and improved the visitor shopping experience.
Along with the growth in consumer numbers has been an increase in the number of direct jobs, up 16.3 percent from 2012 to reach 19 269 in the 2013/2014 fiscal year. Economists analysing the V&A Waterfront have noted the creation of two types of job (two avenues via which GDP growth occurs):
- direct employment from ongoing operations and capital ventures;
- jobs indirectly supported by the multiplier effects of capital investment and the sales turnover of retail tenant
- The GDP growth has also been attributed to property developments in the new Silo district and Watershed Africa’s new craft and design
The dramatically increased significance of the Waterfront would not be possible without the construction of new buildings. Pointing out the foundational imperative of small businesses flourishing, the V&A recently committed R500 million to the establishment of the Zeitz Museum of Contemporary Art Africa, situated in the Grain Silo complex. Nearby, the No.1 Silo (housing investment firm Allan Gray) is notable as part of the award-winning network generating tenant rentals.
Industry players have noted the importance of long-term planning in attracting investors. Strategies spanning 15-year periods have thus far led to the allocation of 400 000m2 of the available 600 000m2 for projects in and around the Waterfront. External factors heightening the potential for commercial property returns include the current expansion of the Cape Town International Convention Centre (CTICC); and the Western Cape Government’s intention of sale of city land adjacent to the V&A. In the former case, events and conferences attract retailers, restaurant owners and caterers, while the latter presents development opportunities for investors. The V&A Waterfront has already expressed interest in obtaining housing development rights: a greater number of residents translate into increased commercial activity (plus returns on the residential market) for the full spectrum of participating stakeholders.
Future of the Waterfront
The current short-term development focus, the Silo district is on schedule for completion in early 2017, at an investment of R1.5 billion. Four developments – reflecting continued high demand for office and residential areas with harbour views – are set to introduce over 35 000m2 of mixed-use space.
1. No. 3 Silo will offer around one hectare in the form of 75 luxury apartments;
2. No. 4 Silo will encompass a 4000m2 Virgin Active facility;
3. No. 5 will feature 13 500m2 of corporate office space upon completion in mid-2016, providing working space sufficient for 2500 staff.
4. No. 6 will house an 8000m2, 220-room international hotel.
Further along the development timeline is the City of Cape Town’s vision for a new Waterfront. Announced late last year, the vision to overhaul the Foreshore is intended to restore access via the central city to the waterfront. Involving the City, the provincial government, Transnet National Ports Authority and the V&A Waterfront, the Port Gateway Precinct Plan has, as its initial stage, the opening of a new cruise liner terminal at E berth.
The direct linking of central Cape Town and the harbour is to be accompanied by the opening of previously inaccessible land to create a ‘people-friendly’ environment. This would entail new commercial, residential, and retail elements along the Foreshore while contemporaneously executing multi-billion rand port expansion plans. Since the vision has been conceptualised within a fifty-year frame, no specific courses of action have yet been formalised.
The eventual intention is to double the city’s container-handling capacity, in order to meet the regional economy’s growing freight demands. Aside from retailers, businesses holding a stake in industrial property (such as warehousing) or logistics stand to benefit from Cape Town’s long-term seafront redevelopment.