With all the excitement of a property transaction whether you’re a first-time buyer or an old hand in buying property it remains important to consider which vehicle or structure in terms of ownership will be best suited to your needs. There are a few key factors to consider which will help you decide how to buy your first or next property. These factors should be considered with every such transaction as it will differ depending on the circumstances.
Rental income from the property will be taxed against the individuals respective tax bracket ranging between 18% to 45%, however, there is some tax relief in the form of capital gains tax exclusions in some circumstances, for example:
- If the property was the primary residence of the individual a R2 million exclusion on any capital gain is allowed, which means that you will only pay capital gains tax when the profit from the sale of the property exceeds R2 million.
- Individuals further enjoy an additional R40,000.00 exclusion on capital gains each year.
Rental income from the property will be taxed at 45% as it is the income tax rate that applies to trusts. Trusts are also taxed at 80% for capital gains thus resulting in an effective capital gain tax rate of 36% (45% x 80% inclusion rate). The income and or capital gains can be distributed to the trust beneficiaries to be taxed in their hands and at their respective tax brackets, this principle is known as the conduit principle and there are certain limitations thereto. (See our article on the conduit principle for a better understanding of how this mechanism works.)
Another point to keep in mind is the recent tax legislation, known as Section 7C of the Income Tax Act 58 of 1962 (“ITA”), determining that loans advanced to a trust by a connected person of the trust may no longer be interest-free and must the taxed at the current official interest rate of 7.75%. There are exemptions where Section 7C does not apply, for example, in the event that the interest free loan is used by the trust to acquire property which the person granting the loan would be using as their primary residence. (See our article on Section 7C loans for more information on the topic.)
Rental income from the property will be taxed at 28% as it is the income tax rate that applies to companies. Companies are also taxed at 80% for capital gains thus resulting in an effective capital gain tax rate of 22.4% (28% x 80% inclusion rate)
Section 7C of the ITA also applies to loans made to companies by a connected person of the company.
Ownership in one’s personal name will be riskier due to it being susceptible to attachment by creditors because the property will form part of one’s estate. Where the property is in the name of a trust or company it will be protected more and will not form part of any shareholder, trustee or beneficiary’s personal estate.
Depending on what the property is intended to be used for and the duties of each co-owner. It is simple to own and manage a property if it belongs to yourself in your own name or even with joint ownership between your spouse and yourself, however, if you have multiple investors and co-owners of a property or multiple properties a company or trust will be better suited in terms of co-ownership and manageability.
Succession and exit strategy
Where must the property go to after your death, must it remain in a business or trust or be inherited by you children to do with as they see fit. If the investment is aimed at commercial objectives it will be better to make use of a company or trust from a business perspective, even if you are investing in property for personal or retirement provision purposes a company or trust structure will still be advisable.
Should you own the property in your own name it will form part of your personal estate and upon death trigger estate duty and executor’s fees on the value thereof and if sold from your estate further capital gains tax will also be payable by your estate.
If the property is owned by a company or trust, your death will not affect the ownership status thereof.
Cost and complexity
Buying property in one’s own name is the fastest, simplest and cheapest way to go about it, but might not be the cheapest or best solution in the long run depending on the intention of the buyer(s) and the afore mentioned and discussed factors.
From the above it is thus clear that there is no direct answer to how one should purchase property and will the circumstances in each event have to considered. A mixture of entities forming various structures can also be an option such as buying through a company and owning the shares in the company through a trust.
Certain tax calculations, risk assessments and succession considerations need to be made in order to choose the correct ownership vehicle or structure.
If you are unsure – get in touch, we can help.