This has to be one of the most misunderstood concepts of the CGT legislation
EVER SINCE Jesus extolled the Pharisees to “render unto Caesar that which is Caesar’s” (as recorded in Mark 12: 13-17), recalcitrant taxpayers have sought to disprove that a portion of some amount accruing to them actually belongs to Caesar, and should accordingly not be rendered.
For many years in South African tax law, there has always been this debate between receipts of a ‘revenue’ nature, versus those of a ‘capital’ nature. This debate was due to the fact that the former was taxable, whilst the latter was not. Many a day has been spent in court debating whether a particular receipt is capital or revenue.
Now we have Capital Gains Tax (CGT), which was introduced in October 2001. This has not however removed the debate, since capital gains are still taxed at an effective rate lower than that of income—40% of the normal tax rate in the case of individuals, and 80% of the normal tax rate in the case of corporate taxpayers.
The CGT legislation (which is actually part of the Income Tax Act in the form of the Eighth Schedule) has also added some twists. Like most areas of tax law, there is “the rule”, and then there are “the exceptions to the rule”. One of those “exceptions” is the fact that if you sell your home, which qualifies as your ‘primary residence’, SARS will keep their grubby paws off the first R2 million of any profits that you may make on the deal.
Not too shabby, Nige!
The problem comes in with this definition of ‘primary residence’, which should be fairly obvious—but can cost a fortune in tax if your particular property does not qualify.
Paragraph 44 of the Eighth Schedule defines a ‘primary residence’ as “a residence—
1. In which a natural person or a special trust holds an interest; and
2. Which that person or a beneficiary of that special trust or a spouse of that person or beneficiary –
a. Ordinarily resides or resided in as his or her main residence; and
b. Uses or used mainly for domestic purposes”.
In simple English, it means that you (as an individual) must both own and live in the property to qualify for the primary residence exemption.
Interestingly enough, the definition of ‘residence’ includes fixed property in the conventional sense, but could also include a caravan, boat, or mobile home in which you reside on a permanent basis.
Now consider the following scenarios—all of which have ended in tears:
- You have purchased a property that is owned by a private company. You own 100% of the shares in the company. You decide to sell the property—do you qualify for the primary residence exemption?
The answer is no, since the owner of the property is not a natural person. Your company also wouldn’t qualify for the R40 000 annual exemption available to individuals, and will therefore pay CGT at an effective rate of 22.4% from the first R1 of any gains.
- You have purchased a property in your own name, but do not reside in it, having chosen to live with your parents. This is the only property that you own. Do you qualify for the primary residence exemption when you sell the property?
The answer again is no, since you did not physically reside in the property on a more or less permanent basis. You will pay CGT at an effective rate of between 7.2% and 18% (depending on your overall taxable income)—although if you did not make any other capital gains during the year, the first R40 000 of your gain will be exempt from CGT.
- You have purchased a property in a trust. You and your family live in this property. When you sell the property, will you be able to claim the primary residence exemption?
Once again, the answer is no, unless the trust is a ‘special trust’. Section 1 of the Income Tax Act defines a ‘special trust’ as being a trust set up either for the benefit of someone who is mentally or physically disabled to the extent that they are unable to earn their own living or manage their own affairs, or set up in terms of a will whereby the youngest beneficiary is no older than 21 years of age.
Any other trust is considered to be an ‘ordinary trust’, not qualifying for the exemption. An effective 36% CGT is thus payable from the first R1 of any gains made.
On the upside, there are situations where you will be able to claim the primary residence allowance, even though you were not resident in the property at the time of sale. These include:
- You have purchased a new property intended to be your primary residence, but had not sold the old property at the time the new one had been acquired. The old property did however remain on the market until actually sold.
- A couple getting married occupies two separate residences prior to their marriage. One of the spouses sells their property and moves into the property owned by the other spouse, or both properties are sold and the couple acquires a new property in which to reside.
It is important to note that only one residence may be a primary residence for any period during which the person held an interest in more than one residence. For instance, in our marrying couple example, if the wife purchased (or was donated) an interest in the residence occupied jointly as a married couple, and this residence was subsequently sold, but she had not yet sold the residence that she occupied prior to their marriage, she would only be able to claim the primary residence exemption on one of the properties, not both.
In cases where the property is owned jointly (e.g. by the married couple in our example), the R2 million must be apportioned in accordance with the percentage interest in the property.
Another thing to consider is if you are renting out a portion of the property, or are conducting business activities on a portion thereof. When you sell, the primary residence exemption must be apportioned according to the area used for residential and business purposes. You cannot claim the portion relating to business usage.
For example, you make R1 million profit on a residence, 20% of which is used for business purposes. R200 000 of this gain will be subject to CGT, whilst the remaining R800 000 will be below the primary residence exemption amount, and thus be exempt from CGT.
Your CGT liability will thus amount to between R14 400 and R36 000 (depending on your overall taxable income). If you have no other capital gains in that particular tax year, the first R40 000 will be exempt, which will reduce your CGT liability to zero in this case.
Steven Jones is a registered SARS tax practitioner, a practicing member of the South African Institute of Professional Accountants, and the editor of Personal Finance and Tax Breaks.