The property market has been booming over the past few years, and most people who have sold properties have had cause to worry about whether the sale will result in their having to pay tax on the profits.
However, the recent slowdown in the property market means you may end up with a loss if you take into account all the amounts that determine the cost of the property (the original transfer duty you paid if the property is residential, legal fees, valuation fees and so on). The question that then arises is: what can you do with the loss?
The first question you have to ask yourself is whether the property was held on capital (capital gain) or revenue (income) account.
Generally, a home would be viewed as an asset you held on capital account (that is, not part of a profit-making scheme) and therefore as something that will result in a capital gain if sold. But what about other properties you may own: a holiday house by the coast? A flat you rented out? A property your friend recommended you buy off-plan "because by the time it's ready for transfer you'll be able to sell it for a fat profit"?
If you bought the property with the main intention of making a profit on its sale or have held the property for a very short time with a view to making a profit on its sale (such as the example of the off-plan purchase), the property would probably be viewed as having been owned in order to earn an income and therefore be regarded as having been held on revenue account.
If, on the other hand, you bought the property as an investment, to derive income from the rental, or to hold for the long term as, say, a holiday home, it would generally be viewed as having been held on capital account.
The distinction is important, because if you make a loss when you sell the property, the way in which that loss is treated for tax purposes will be completely different depending on whether the property was held on capital or revenue account.
You must, however, remember that you won't simply be able to decide when you sell whether to treat the property as having been held on capital or revenue account in order to derive the maximum tax advantage.
The South African Revenue Service (SARS) will look at all the circumstances surrounding the purchase, ownership and sale of the property to determine whether you have correctly recorded the nature of the costs and proceeds. These would include:
- The original purchase of the property. What you stated was the reason for the purchase in your previous tax return. The 2007 tax return does not require this information, but prior tax returns did ask for it.
- The period for which the property was held. Whether you, for example, reflected it as trading stock, deducting the interest on the purchase despite it not earning any rental.
- What you stated as your reasons for selling the property. Do the facts support these reasons?
Offsetting the loss
So what exactly is the difference between what happens to the losses that arise if you held the property on revenue account versus on capital account?
If you held the property on revenue account, you can deduct all the costs directly related to the property from your income, and you need to include the proceeds from the sale in your income.
You will then be able to offset the net loss against your other income derived from, for example, your salary or investment income (interest or foreign dividends), or capital gains from, say, the sale of another property.
However, if you held the property as an investment (on capital account), and the costs - the "base cost" in capital gains tax (CGT) jargon - exceed the proceeds, you will generate a CGT loss.
This loss may generally be set off against other capital gains you have generated during the year (for example, capital gains you have generated from the sale of shares or other properties you held on capital account).
But the CGT loss may not be set off against other (revenue account) income, such as your salary, interest income or taxable foreign dividend income. Nor may it be set off against profits from the sale of assets held on revenue account (for example, profits from trading shares or developing property).
If the loss on the sale of the property is the only CGT event you had during the year, it will be reduced by the CGT abatement (currently R15 000) and carried forward to the next year.
It is important that you keep track of the loss because it may be set off against taxable capital gains you realise from sales of other assets in future years. However, should such taxable gains (after the abatement) not arise, the loss may never be used.
Connected person
A further limitation on CGT losses that must be borne in mind is that if such a loss was generated as a consequence of selling a property to a connected person, you may only claim the CGT loss against the CGT profits generated as a consequence of the sale of another asset to the same person. Examples of a connected person are a member of your family, a trust in which you and/or your family are beneficiaries, or a company or close corporation in which you hold more than a 20-percent interest (alone or with your family).
This restriction is given the term "clogged losses" and may result in the gain never being claimable.
It is important to remember when selling, or giving, a property to a "connected person" that its proceeds are deemed to be the market value at the time. So, even if you generate a real loss from the sale, you may not necessarily generate a CGT loss.
Clearly, a CGT loss on the sale of a property can be a problem, because unless you have also experienced a CGT profit from the sale of another asset during the year, you will not benefit in that year from any relief from the tax payable on your other income.
- Deborah Tickle is a tax partner at KPMG.