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The creation of wealth through property and / or land is undoubtedly one of the most tried and tested methods used throughout recorded history. As humans, we naturally tend to feel more secure in being able to see and physically touch the assets we invest in, giving them a sense of realism that a diversified portfolio of securities may lack.
However, like all investments, there are certain advantages and disadvantages to the way you structure your portfolio. Specifically, you need more information about the tax structures you have identified: personal property, a trust, or through a business. Let’s look at each of these.
Personal property
Buying a property in your name will be the simplest structure to implement. From a tax perspective, the net rental income, after allowable expenses, is added to your personal taxable income and the tax liability will be calculated according to the individual pay-for-income (PAYE) tables.
In the event that the properties are in your personal name at the time of your death, depending on the size of your estate, they may be subject to an estate tax of 20% of the value of your taxable net worth. Also, if your property is left in the hands of your children, your death will trigger a “presumed” sale of the property, resulting in a capital gain and possible tax on this gain depending on the size. Currently, in the event of death, the first R300,000 of capital gain is excluded from tax and 40% of the balance of the gain is included in your taxable income in the year of your death.
Establish a trust
Depending on the long-term management of real estate assets, a trust can be an effective, albeit more complicated, structure for building a portfolio of family properties. Trusts come with their own set of advantages and disadvantages, and these should be questioned thoroughly before deciding to move forward.
For example, if you want to purchase the property for cash, you must first transfer these funds to the trust and then the property must be purchased in the trust’s name. This transfer will create a loan account to your trust. Section 7C of the Income Tax Act now provides that an annual gift is activated in the hands of the person providing the loan. The grant amount is the difference between the interest actually charged on the loan, if any, and the interest the trust would have paid if the interest had been charged at the current “official interest rate.”
This gift is subject to normal gift tax rules and you can use your R100,000 annual gift exemption to offset or reduce any potential gift tax implications. Remember that this loan account would be included in your estate as an asset that can trigger an estate tax liability.
In case the purchase is financed by a bond, the property is still purchased in the trust’s name and therefore the bank should agree to this. Invariably, the bank will then ask you to offer a personal guarantee of the surety. If you are making any contributions to the repayments of the bonds, this would be done through the trust and then it would re-create a loan account between you and the trust.
However, a potential advantage with a trust structure is that the income generated by the trust can be distributed to the beneficiaries of the trust under Section 25B of the Income Tax Law.
In summary, this income is therefore taxed in the hands of the beneficiary through the principle of conduit. The beneficiary may have very little or possibly no taxable income, effectively reducing the net tax liability payable on rental income.
It is important to note that Section 25B is subject to the provisions of Section 7 of the Income Tax Act. In summary, this section addresses anti-tax structures to determine who is liable to pay income taxes. This may result in a circumstance where, although the income is distributed to the beneficiary of the trust, this income could be considered as that of the donor.
Depending on the size of the property portfolio in the trust, you may be able to save substantially on estate taxes and capital gains tax in the event of your death, as only your potential trust loan account is included in your heritage. Any capital increase in property values over time is protected from the time they become assets within the trust and your death is not a triggering event for a deemed disposal of property for income tax from capital.
However, keep in mind that if a property within the trust is sold for any purpose, the inclusion rate for the capital gains tax calculation is 80% of the gain, as opposed to your personal capacity, where this it is 40% and there are no annual taxes. exemption by a trust. Again, this negative impact can potentially be reduced by conferring the proceeds of the sale to the beneficiaries of the trust.
Establish a business
Using a business structure to establish and grow a portfolio of properties can be a very effective balance between maintaining control over assets while maintaining limited liability between your personal affairs and those of your assets. the property. Again, depending on how you intend to acquire the property’s assets, financial institutions may require certain personal guarantees when financing these acquisitions, however, these may be underwritten with certain insurance policies to limit risk.
When establishing the company, you can decide who will be the shareholders of the company and in what proportion. The value of your equity interest is included in your estate after your death for possible estate taxes and executor’s fees, whereas if you sell all or part of your equity interest in your lifetime, you could potentially be subject to income tax. capital.
From an income tax perspective, the company’s net income, after allowable expenses, will be subject to normal corporation tax. Any subsequent after-tax profit distributed to shareholders first would be subject to a 20% dividend withholding.
Closure
The points above are a very general overview of these three main structures. There will always be a good number of nuances applicable to everyone’s personal and family circumstances. I would always recommend that you do your homework, as well as consult with a professional financial planner and / or the CA (SA) letter holder who can help and guide you through the complexities of the tax consequences of each option.
