Each buyer’s situation is different, so there is no one correct answer to this question. The entity in which a buyer should buy his property will depend on his personal financial circumstances and the reasons why he wants to buy the property. In order to make an informed decision, the advantages and disadvantages of Adrian’s options must be considered.
Purchase in personal capacity
If Adrian purchases his holiday home in his personal name, the following principles will apply:
- No transfer duty is payable on the first R600 000.00 of the purchase price.
- From R600 001.00 to R1 000 000.00 transfer duty at a rate of 3% of the amount above R600 000 will be charged.
- From R1 000 001.00 to R1 500 000.00 transfer duty of R12 000 plus 5% of the amount above R1 000 000.00 will be charged.
- From R1 500 0001.00 transfer duty at R37 000.00 plus 8% of the amount above R1 500 000.00 will be charged.
- In the case of property purchased primarily as a primary residence, the first R2 million of the capital gain on the sale is disregarded for purposes of capital gains tax.
- If the property is not purchased primarily for residential purposes the sale will have capital gains tax consequences. R30 000.00 of the total capital gain will be disregarded. After that, 33.33% of the capital gains derived from the alienation of the property will be included in a seller’s annual taxable income.
- At the owner’s death the holiday home will form part of his estate for estate tax duty purposes. A deduction of R3.5 million against all assets in the estate is allowed with the balance of the estate taxed at 20%.
- Capital gains tax will also be relevant at the owner’s death, regardless of whether the beach house is sold or not. The fair market value of the property at the date of the owner’s death will be determined and consequently, the growth in the value of the property in his estate will be taxed. If the property is bequeathed to the owner’s surviving spouse, no capital gains tax will be payable. If however the surviving spouse dies or the property is sold, the capital gain on the disposal will be calculated from the date the property was bought.
- The property will continue to be susceptible to seizure by creditors if the owner of the property becomes insolvent.
- If the owner dies, his will determines to whom the beach house must be bequeathed. However, complications may arise where more than one heir stands to inherit the beach house. Questions such as who is entitled to use it, who is responsible for the maintenance thereof and who is entitled to the income earned thereon, are often questions that arise when property is owned by more than one owner.
Purchase in family trust
If Adrian however purchases the beach house in the name of his family trust, the following principles will apply:
- Transfer duty was calculated in the past at a fixed rate of 8% from the first Rand. However, since 23 February 2011 trusts pay transfer duty at the same scale and with the same exemptions as natural persons.
- Capital gains tax can be calculated in two ways. First, the capital gains can be taxed in the hands of the trust, in which case 66.6% of the profit is included in the trust’s taxable income and taxed at 40%, which results in an effective capital gains tax rate of 26.7%. Secondly, the capital gains can be distributed to the beneficiaries, in which case the capital gains will be taxed at the respective income tax levels of the beneficiaries. Individuals pay income tax at a rate ranging between 18% and 40% and accordingly capital gains tax at a maximum rate of 13.3% will apply.
- Income earned by the trust will, as in the above case, be taxed in the hands of the trust, or it can be distributed to the beneficiaries in order to be part of the gross taxable income of the various beneficiaries.
- Income tax and capital gains tax can therefore be reduced by distributing the income and the capital gains of the trust among major beneficiaries with lower income tax levels.
- No donation tax is payable if the capital gains made on the disposal of the beach house is distributed to beneficiaries.
- The beach house will not form part of an owner’s estate for tax purposes, and accordingly the trust plays an important role in estate planning.
- Since the beach house is not part of the owner’s estate, no capital gains tax is payable upon his death.
- The complications that arise when the beach house is owned by more than one owner can be largely eliminated as the trust remains the owner of the beach house, even after the owner dies.
- The trust is a separate legal entity and the trust assets are accordingly protected from seizure by creditors.
- Should financing be required to purchase the beach house, the trustee can apply for financing and the rent the property to Adrian and/or others in order to service the instalments.
It is clear from the above explanation that the objectives of the buyer must be taken into account in order to identify the most appropriate entity in which he can buy his new property. The buyer must therefore ask himself the following questions to determine his position:
- What do I want to do with the property? Do I buy it for a short term period, or do I keep it as a long term investment?
- How do I finance the property? Will it be a rental property? How do I structure this?
- Will I restore and renovate the property in order to sell it again at a profit, or do I buy the property with the intention of bequeathing it to my children one day?
- Do I wish to protect my assets from creditors?
- Will the property be my primary residence?
Considering Adrian’s circumstances and objectives, a trust will be an appropriate entity in which to purchase his beach house, especially because he sees it as a long term investment. Adrian will in this case enjoy protection from creditors and not pay estate duty. He can also nominate his sons as capital beneficiaries in the trust to ensure that the beach house is inherited by his sons. His wife can be nominated as an income beneficiary in his trust to earn the rental paid on the property.
Finally, the Minister of Finance’s budget speech for 2013 must be kept in mind. It appears that the flow of income and capital gains through trusts to beneficiaries may come under fire in future. All income not actually distributed to beneficiaries may be at risk of being taxed in the trust. Income that is distributed to beneficiaries will then probably be allowed as a deduction for the trust and taxed as ordinary income in the hands of the beneficiaries.
Yet at this stage the proposed amendments of our tax laws is still only a possibility about which there currently is only speculation. In the meantime it would be advisable to seek professional help in order to assist you in analyzing your financial situation, circumstances and choice of the most appropriate entity in which to buy your property.
The following conclusion can be made: Due to the fact that the first R2 million capital gains made on the sale of your primary residence is exempt from capital gains tax, it may from a tax perspective be preferable to buy your primary residence in your personal capacity. However if your concern is about protection against risk, then a trust that is properly managed is an important option for consideration. If you are buying a second home and your estate is worth more than R3.5 million, you may wish for both tax and protection purposes, to consider purchasing the property in a trust. Most importantly: seek advice as to what is appropriate to your specific circumstances.