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A property tax incentive that’s not so sex-y

Tax should not be primary driver of investment, must make commercial sense – Dr Beric Croome.

JOHANNESBURG – Property investment group IGrow Wealth Investments recently posted the following advertisement on Facebook:

Wiehann O’livier, audit manager at Mazars, soon responded: “No mention is made of the recoupment and the CGT [capital gains tax] implications when the property is sold… Perhaps a good idea to give the public the full picture when you use a tax incentive to advertise.”

IGrow replied: “As every investor’s strategy differs in terms of wealth creation we guide the investor accordingly.”

But what is the section 13sex incentive and what is the full picture?

Dr Beric Croome, tax executive at ENSafrica, explains that the incentive is meant to encourage the building of domestic residences. It allows for a tax deduction of 5% of the cost of the building, improvement or acquisition of any new and unused residential units if the taxpayer owns at least five units situated in South Africa and uses them solely for trade purposes.

The units do not have to be situated in the same development or area as long as they are all located within South Africa, he says.

Where the cost of the apartment is R350 000 or less, and the owner does not charge rental of more than 1% of the cost, the incentive increases to 10%. The 10% allowance may also be claimed where the cost of a standalone unit is R300 000 or less, the owner does not charge rental of more than 1% and a proportionate share of the cost of the land and the bulk infrastructure. These are referred to as low-cost residential units.

Croome says because the incentive is only available when the taxpayer is carrying on a trade, it would generally apply where someone buys units and rents them out to tenants. It could also be aimed at employers providing accommodation to staff to encourage the construction of accommodation. It is available where the units were acquired or built on or after October 21 2008.

The incentive effectively allows qualifying taxpayers to write off the cost of the units if they meet the three requirements.

But as O’livier rightly pointed out, the deduction would only be available as long as the taxpayer owns the units and earns rental. Should the taxpayer sell the units, there would be a recovery of the tax allowance received in prior years and capital gains tax would be levied.

For the purpose of calculating the deduction, the cost of acquiring a residential unit is deemed to be 55% of the purchase price (effectively splitting the cost of the land and the unit) where a new unit was constructed and 30% in the case of an improvement.

The calculation in the advertisement is as follows:

R743 260 (purchase price) x 55% (deemed cost of new unit) x 5 (number of units) = R2 043 965

R2 043 965 x 40% (the old marginal tax rate – for the 2017 tax year, it should be 41%) = R817 586

Croome explains that the annual deduction will be calculated as follows:

R743 260 (purchase price) x 55% (deemed cost) x 5 (number of units) x 5% (deduction allowed per annum) = R102 198

When the units are sold, the deduction allowed up until that point would be recouped and added to the investor’s taxable income. Thus, it is effectively a temporary incentive.

Selling the units for an amount in excess of R743 260 each (assuming no other cost) will also trigger a capital gains tax event.

Ultimately individuals need to consider whether it is a sound property investment by taking the location, rental yield, expenses and other factors into account and seek the necessary advice. A tax incentive should merely be the sweetener, Croome says.

“The tax should not be the primary driver of the investment. It must make commercial sense.”

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I don’t understand what the downside is then? This article implies that it doesn’t really provide a benefit – or are we saying that the incentive is less than what is being marketed on the FB post?
Surely, it is still an incentive that has a benefit for investment over and above just purchasing the 5 units outright?

@jblack I think the article tried to highlight two points – 1) the recoupment and potential CGT implications upon selling and 2) that tax shouldn’t be the sole consideration for investing. Nothing wrong with the incentive as long as that is understood.

Dear Inge

I agree that the points you are raising are important factors to consider. I have found that investors using this tax benefit, are all long term investors who focus on creating a passive income from building up a property portfolio.

The head of property finance at one of our major banks gave me the following example: ” I have build up a residential property portfolio of 50 units and I am getting on average R5000 net rental per unit. So my current income of R 250 000 per month is a passive income that keeps trend with inflation and will give me the same buying power 10 and 20 years from now.”

The Section 13 tax incentive from SARS, as promoted by IGrow, is a fantastic tool giving investors the opportunity to use the tax benefit and build a fantastic passive income stream. But as in the case of all other investments, you need to keep to the basic principles.

So if SARS give you such a huge benefit, use it to build a fantastic long term passive income.

How does the minimum of 5 units work ?

If I bought 4 units last year and a 5th this year, presumably only no. 5 qualifies for the incentive.

If I bought 5 units last year and sell one this year, does this end the deductions for the remaining 4 ?

Tax-incentive-based marketing generally is selective in the information provided.

The other obvious example is the S12J incentive (for venture capital investment), where the marketing trumpets the 100% writeoff but the full long-term tax picture often isn’t disclosed, and there are usually substantial hidden costs.

Again, the main problem is with the marketing, not – in principle – with the incentive.

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