How to buy a property (without losing sleep)

Thinking about buying a property? Exciting times! But before you pop the champagne and sign that offer to purchase, there’s one important question to think through: how should you buy the property?

There’s no magic, one-size-fits-all answer here. The best ownership “vehicle” really depends on your personal circumstances — things like whether you’re a South African tax resident, how you plan to use the property and what your long-term goals are.

For this article, we’ll briefly look at the options that buyers usually choose:

• Purchasing in your individual capacity
• Purchasing through a company
• Purchasing through a trust

No matter which option you choose, buying immovable property involves unavoidable costs. These include either transfer duty or VAT (depending on the transaction), as well as registration costs.

Transfer duty generally applies when the purchase price exceeds R1,210,000, unless the transaction is subject to VAT. VAT applies where the seller is VAT-registered and the property forms part of their taxable enterprise. In all cases, buyers should budget for transfer costs, including conveyancing fees, deeds office fees, administration fees and related disbursements.

South African individuals

South African tax resident individuals are taxed on worldwide income and capital gains.

Any rental income earned from the property is taxed at your marginal tax rate (up to 45%). The good news? Rental income is treated as trade income, which means you can claim deductions for expenses such as municipal rates, repairs, bond interest, insurance and other costs allowed by SARS.

When you sell the property — or when your estate is wound up one day — any capital gain is subject to capital gains tax (CGT) at a maximum effective rate of 18%. If the property is your primary residence, the first R2 million of the capital gain may be excluded from CGT (R3 million once changes announced in the Budget are implemented).

The full value of the property is also included in your estate for estate duty purposes, which is charged at 20% or 25%, depending on the value of the estate (with the CGT deducted for the estate duty calculation). Generally, purchasing in your individual capacity makes sense when the property is your primary residence, or if you want simplicity and you don’t need asset protection or generational planning yet.

South African companies

When a company buys property, transfer duty generally applies at the same rates as for individuals, unless the transaction is subject to VAT.

If both the buyer and seller are VAT registered and the sale qualifies as a going concern, the transaction may be zero-rated for VAT, meaning no VAT and no transfer duty apply. If it doesn’t qualify as a VAT transaction, standard transfer duty will apply.

Companies pay corporate tax at 27% on rental income and profits, with rental income again treated as trade income. Capital gains are taxed at an effective rate of 21.6%, and companies don’t have access to the primary residence CGT exclusion.

It’s also worth noting that holding property in a company doesn’t automatically sidestep estate duty. While the property itself is not dutiable, your shareholding in your personal capacity is.

It’s also worth keeping in mind that if the company declares dividends to you, those dividends will be subject to a 20% dividend tax. In other words, there’s an extra layer of tax when you want cash in your own pocket. If you funded the company via a loan, the good news is that the capital portion of any loan repayments to you can generally be made tax-free.

In light of this, buying a property through a South African company will generally suit you if you intend to grow a property portfolio or want to ring-fence your risk.

South African trusts

Another option, instead of owning property in your own name or through a company, is to hold it in a trust. When it comes to trusts, the first question is always: how was the trust funded? This is important, since the funding method can trigger some less-than-friendly tax consequences if not structured correctly.

Property can be transferred into a trust by sale or donation. This can trigger transfer duty or VAT, and potentially donations tax as well. If the trust buys the property from you with the purchase price still outstanding on the loan account, section 7C of the Income Tax Act may require interest to be charged on that loan (unless the property qualifies as your primary residence). As with any property purchase, transfer duty (or VAT) and transfer costs still apply.

If income or capital gains are retained in the trust, they’re taxed at relatively high rates –  45% for income and 36% for capital gains. Fortunately, the conduit principle can come to the rescue. This allows the trust to distribute income or capital gains to South African resident beneficiaries in the same tax year, so the tax is paid at their individual tax rates instead.

Used correctly, the conduit principle is a tax-efficient way to move money out of the trust. And if the trust has already paid tax on the income or gains, beneficiaries won’t be taxed again when distributions are made. Any loan repayments made back to you are also generally tax-free.

Unlike individuals, however, trusts don’t qualify for the primary residence CGT exclusion.

Trusts are often the best choice for those who are looking for an estate and legacy planning vehicle.

Non-residents

The same broad principles apply to non-resident individuals and entities that own property in South Africa. In addition, non-resident owners must comply with South African exchange control requirements.

Something to keep in mind: non-residents can’t make use of the conduit principle, which means tax rates can be significantly higher when property is held in a trust with non-resident beneficiaries.

Conclusion

What works perfectly for one person may be entirely unsuitable for another. Your individual circumstances, goals and intentions will always determine the best way forward. If you’re unsure which option makes sense for you, make sure to discuss with your tax adviser.