In this advice column, Wendy Foley from Citadel answers questions from a reader who is selling a house that he was renting out.
Q: I bought a house in Pretoria in December 2011 for around R1.1 million. I lived there until October 2013 but then moved to Johannesburg and decided to rent it out.
I did not buy a new place in Johannesburg as I intended to move back to Pretoria eventually. With the monthly rental income I received on my Pretoria property, I paid rates and levies of around R2 000 per month, although I did not pay any municipal rates.
In time, I realised that I was not going to move back to Pretoria again and decided in February 2015 that I wanted to sell my house and found a buyer for it.
My questions relate to how all of this should be reflected in my tax return.
For the last two years I have included the rental income in my return, whilst deducting items such as interest and levies. I paid the full outstanding municipal rates of around R30 000 when I sold my house in June 2015. For the 2016 tax year, can I deduct all of the rates for the period that I was renting out the property, which is about 18 months?
Secondly, when it comes to the proceeds of the sale, am I eligible for the R2 million exemption on capital gains tax for a primary residence?
To answer all of your questions, let us first consider the tax treatment of rental income. Any rental income you receive should be added to any other taxable income you may have, and assessed in its entirety.
The taxable amount of rental income may, however, be reduced, as you may incur expenses during the period that the property was let. Only expenses incurred in the production of that rental income can be claimed. Any capital and/or private expenses won’t be allowed as a deduction.
Expenses that may be deducted from taxable income are your rates and taxes, interest on the bond, advertisements, fees paid to estate agents, homeowners insurance (not household contents), garden services, repairs in respect of the area let, and security and property levies.
It is important that maintenance and repairs should be noted as specific costs and not confused with improvement costs. Improvements are a capital expense and cannot be claimed as an expense. They can, however, be included in the base cost of the property to effectively reduce the capital gain (or loss) on the disposal of the property, for capital gains tax (CGT) purposes.
To answer your first question then, the municipal rates were paid as a lump sum amount of R30 000 in June 2015 on the sale of the house. Assuming that the property was still being let during the 2016 tax year that runs from March 2015 until February 2016, the seller would be able to deduct the full amount of R30 000 in the 2016 tax year.
On the second question, current legislation entitles individuals to disregard any capital gain on the disposal of their primary residence if the proceeds do not exceed R2 million. In such event the individual does not need to determine the base cost of the residence.
In order to claim this exclusion we need to determine what qualifies as a primary residence.
To meet the requirements, it must be a structure (including a boat, caravan or mobile home) which is used as a place of residence by an individual. An individual or special trust must own an interest in the residence. And the individual with an interest in the residence, beneficiary of the special trust, or spouse of that person or beneficiary must ordinarily reside in the home and use it mainly for domestic purposes as his or her ordinary residence.
The question in your case is what will happen to the CGT exclusion if you rent your residence out to a tenant for a period of time and then decide to sell the house?
A residence is treated as having been used for domestic purposes during any continuous period of absence, while the residence is being let under the following circumstances:
1) The residence must not be let for more than five years. You, your spouse or a beneficiary of a special trust must have resided in the residence for a continuous period of at least one year before and one year after the period of absence.
2) You treated no other residence as a primary residence during your absence.
3) You were temporarily absent from the Republic or employed or engaged in carrying on business in the Republic at a location further than 250km from the residence.
In this case, you do not meet all the requirements. Although you did use it as a primary residence before renting it out, you were not further than 250km away and you did not move back in for at least a year afterwards.
It would therefore appear that you would not get the R2 million exemption and you would be liable for CGT on the sale of the house.
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