Wealth through property
RETIREMENT: KNOW MOST TAX-EFFICIENT WAYS TO CREATE A FINANCIAL WEALTH PORTFOLIO
Personal ownership, a company or trust – there are certain advantages and disadvantages.
AMoneyweb reader asked: I want to create a financial wealth portfolio that I can enjoy in my retirement age, and that will enable me to leave something behind for my children. I would like to invest in one or two properties as wealth creation, but I’m unsure of the South African tax laws. Kindly advise of the best legal ways of paying the least amount of tax.
Gareth Collier answers:
Purchasing property in your own name will be the simplest structure to put in place. From a tax perspective the net rental income, after allowable expenses, is added to your personal taxable income and the tax liability will be calculated in line with the individual pay-as-you-earn tables.
Should the properties be in your name at the time of your death – depending on the size of your estate – they may be subject to estate duty of 20% of the value of your net dutiable estate.
In addition, should your properties be left to your children, your death will trigger a “deemed” sale of the property which will cause a capital gain and possible tax on this gain depending on the size.
Currently, on death, the first R300 000 of capital gain is excluded from tax with 40% of the balance of the gain being included in your taxable income in the year of your death.
Se ing up a trust
Depending on the long-term handling of the property assets, a trust can be an effective, although more complicated, structure of building a family property portfolio. Trusts come with their own set of advantages and disadvantages, and these should be thoroughly questioned before deciding to move forward.
For instance, if you wish to purchase the property in cash, you will first need to transfer these funds to the trust and the property must then be purchased in the name of the trust.
This transfer will create a loan account to the trust from yourself. Section 7 C in the Income Tax Act now provides for an annual donation to be triggered in the hands of the person who provides the loan. The amount of the donation is the difference between the interest that is actually charged on the loan, if any, and the interest that would have been payable by the trust had the interest been charged at the prevailing “official rate of interest”.
This donation is subject to the normal donations tax rules and you can use your R100 000 annual donations exemption to offset or reduce any possible donations tax implication. Remember this loan account would be included in your estate as an asset which may trigger an estate duty liability.
Should the purchase be financed with a bond, the property is still bought in the name of the trust and therefore the bank would need to agree to this. Invariably, the bank would then ask you to stand personal surety for the bond.
If you are making any contributions to the bond repayments, this would be done via the trust and you would then again be creating a loan account between yourself and the trust.
However, a potential advantage with a trust structure is that the income the trust generates may be distributed to the beneficiaries of the trust under Section 25B of the Income Tax Act. In summary, this income is taxed in the hands of the beneficiary by means of the conduit principle. The beneficiary may have a very low or possibly no taxable income which effectively lowers the net tax liability payable on the rental income.
It is important to note that Section 25B is subject to the provisions in Section 7 of the Income Tax Act. In short, this section addresses anti-avoidance structures in determining who is liable to pay tax on the income.
This may result in a circumstance where, although the income is distributed to the beneficiary of the trust, it could be deemed to be that of the donor. Depending on the size of the portfolio of properties in the trust, you may stand to save substantially on estate duty and capital gains tax in the event of your death, since only your possible loan account to the trust is included in your estate.
Any capital growth on the property values over time is sheltered from the time they become assets within the trust and your death is not a trigger event for a deemed disposal of property for capital gains tax.
Establishing a company
Using a company structure to establish and grow a property portfolio can be a very effective balance between maintaining control over the assets while keeping a limited liability between your personal affairs and those of the property assets.
Again, depending on how you intend on acquiring the property assets, certain personal sureties may be required by financial institutions when funding these acquisitions. However, these can be underwritten with certain insurance policies to limit the risk.
When establishing the company, you may decide who, and in what proportions, will be shareholders. The value of your shareholding is included in your estate upon your death for possible estate duty and executor fees. Should you sell all or a portion of your shareholding in your lifetime you would potentially be subject to capital gains tax.
The company’s net income, after allowable expenses, will be subject to company tax. Any subsequent profits after tax that are to be distributed to shareholders would first be liable for dividend withholding tax of 20%.
Consult a professional to guide you through complexities of options
Recommendation
The above points are a very general overview of these three main structures. I’d always recommend you consult with a professional financial planner and/or CA(SA) charter holder who can guide you through the complexities of the tax consequences of each option.