Question:
I bought my in-laws' house at around half of its real value as they were about to lose it. They don't pay me rent as they cannot afford to.

With this being my second house, how will I be affected by tax and how can I avoid paying unnecessarily?

Answer:
Every time the topic of taxes comes about, one can’t help but be reminded of Benjamin Franklin’s famous quote: "There are only two certainties in life: Death and Taxes."

When it comes to potential tax liability on a fixed residential property, there are three types of taxes that come to mind, namely:

• income tax on rental income;

• capital gains tax (levied against any capital appreciation on the asset);

• estate duty (levied upon death)

A South African resident is liable for capital gains tax on the disposal of any asset on or after 1 October 2001 on any amount where the proceeds of an asset exceed the base cost. It is therefore a tax on capital appreciation of an asset. Considering that the property mentioned was purchased at a drastically reduced price it would stand to reason that there is an automatic gain for you should you choose to dispose of it.

Although there are a number of intricacies involved in ascertaining base costs and proceeds values the broad guideline is that it would be the difference between the value at which you acquired the asset and the value at which you disposed of it. This disposal could be by way of actual sale or donation of the asset, or through a deemed disposal (upon death) where the asset is then either bequeathed to another person or physically disposed of by the executor to wind up the estate.

Therefore, in calculating any potential capital gains tax liability, one should first establish a base cost. This should then be subtracted from the proceeds of the asset that is being disposed of, which would indicate the capital gain. This capital gain may then be reduced by an applicable exclusion of:

• R17 500 — current exclusion allowed annually;

• R120 000 — current exclusion in the year of death

This gain would then be included in one’s income tax calculation at an inclusion rate of 25 percent. What this means is that for every R1 capital gain, one would include 25c of that in one’s income tax calculation. Therefore, one’s effective rate of capital gains tax would be determined by multiplying one’s marginal rate of tax by 25 percent.

For example, a person in the highest tax bracket (40 percent) would have an effective capital gains tax rate of 10 percent (marginal rate [40 percent] x inclusion rate [25 percent] = 10 percent).

The other taxation consideration is estate duty. This is only levied upon death and is charged on the total net value of one’s estate at a flat rate of 20 percent. A person’s gross estate is made up of 'property' meaning fixed assets (e.g. residential property, vehicles, business assets) of any nature including rights to property (e.g. limited interests) as well as deemed property (e.g. investments, pension funds & cash). This value is reduced by any allowable deductions (e.g. executors fees, funeral costs, outstanding tax and mortgage bonds) as well as any exclusions (most notable of which being assets bequeathed to a spouse) and finally deducting the R3.5-million abatement. This essentially means that the first R3.5-million of one’s net estate is exempt from any estate duty.

Therefore, in short, the two taxes of primary importance for you would be capital gains tax on capital appreciation of this property which becomes payable upon disposal (through sale, donation or death) and of course estate duty which is levied on your entire net estate (including this property) upon the value that exceeds R3.5-million.

All the best.

acsis Limited is an authorised financial services provider. The response to the question covers some of the issues in a general and factual manner and does not constitute advice. It is important to consult with a financial planner who, after an analysis of the individuals’ personal needs, goals and circumstances, will be able to provide comprehensive and appropriate advice.

If you would like acsis to put you in touch with an independent financial planner, click here!

RSS

Digg

de.li.cious

facebook

MORE PERSONAL FINANCE

What we waste money on `What do you waste money on?` Most respondents in a new poll seem to agree...

How to budget The disease? Overspending. The cure? Drawing up a budget. Kabous le Roux on how to do it...

Taxing retirement funds The tax considerations of various retirement funds before, upon and after retirement...