Rental property return on investment (ROI), tax and profitability shouldn’t be that difficult. The rental property business in South Africa should be simple. To simplify the process, let’s break down the calculations and make tax breaks, income and expenses understandable.
Rental Income AND expenses (Basics)
Rental income is the money you earn from tenants. In accounting, you minus your expenses from your income to get your profits, however, tax is calculated slightly differently. Let’s look into income and profit first.
Concerning income – You have gross and net income. Gross rental income is the full rent amount you collect every month. Net rental income is the amount left after expenses like maintenance and rates/taxes.
Rental Income – Expenses = Income
Expenses include rates, taxes, levies, parking levy, water rates and insurance costs. You can also include your bond interest as an expense for tax purposes.
For Example:
- You rent out a flat for R 8 000 per month.
- Monthly expenses include:
- Maintenance: R 500
- Property rates: R 800
- Insurance: R 200
- Net income = R 8 000 – (R 500 + R 800 + R 200) = R 6,500.
Example:
- You own a townhouse with a monthly levy of R2,000.
- Factor this into your calculations before buying.
Action Tip: Create a budget for your property expenses.
How to Calculate Property ROI
The formula for calculating the ROI on your property investment is:
ROI = (Net Income ÷ Total Investment) × 100
The true ROI can be difficult to calculate. This is because the actual total investment is a fraction of the property value. I like the Frugal 1% rental rule. A property should return 1% of its purchase price per month after rates, taxes and levies. Therefore:
Net Monthly Rent = Monthly Rent – (Rates, Taxes, Levies)
Percentage = Net Monthly Rent / Purchase Price) x 100
For more details, visit How to Calculate ROI on Rental Property.
Managing Financial Risks
Every investment has risks – and some risks have a massive impact on your finances. Here’s how to reduce them:
- Tenant Screening: Check credit history and references.
- Landlord Insurance: Get it if your tenant doesn’t play along.
- Diversify: Invest in different areas to spread risk.
Interest Rates and repayments
If you have a bond, you could either have a fixed or variable interest rate. It’s generally better to have a variable interest rate, as fixed rates are often >3% than variable rates.
But did you know you can negotiate your interest rate? On a R 400 000 property, a 0.5% difference can mean you pay more than R 30 000 less! Send your bank an email to lower your interest rate now!
Financing Your Property
Most people need a home loan to buy property. The short version is that you need to give the bank proof of income. You then need to pay back. There are bond, transfer and other costs involved and you might need a deposit!
If you’re fortunate enough to buy a property cash – wow! Good! But take note of the tax implications.
tax on rental income
I see rental income as dividends of your investment, whereas the property value increase is like stock growth. Rental income and proceeds from a sale are taxed very differently.
This is different for companies, trusts and individuals. For companies, their normal tax rate is 27%. For trusts, it’s 45%. Individuals have a sliding scale depending on their salary (PAYE).
Rental income is taxed at your normal tax rate.
Capital Gains Tax (CGT) is payable on the proceeds from a sale.
How is capital gains tax calculated on property?
Companies are taxed at 27%.
Trusts are taxed at 45%.
Individuals have a sliding scale (based on salary // PAYE). After deducting fees, upgrades, and the purchase price from the selling price, you get the taxable amount (proceeds).
For Individuals, the first R40,000 is tax-free (an exclusion). Companies and trusts do not have the R 40 00 exclusion.
Then, 40% of the rest (after the exclusion, if any, has been deducted) is taxed at your rate.
If it’s your primary residence, then the first R2m is tax-free (if the property is in your name).
Property Investment types
I want to deviate slightly here, because different property types are taxed differently. You get three types of properties: cash flow, capital gain and unicorn properties.
Cash flow properties have a >1% rental factor. The rent is fairly high but the property value doesn’t increase that much over the years. These tend to be areas with lower property prices. These can be lucrative if bonded, as all profits are taxed at your normal rate. It’s ideal if you want to use other people’s money to buy property.
Capital gain properties increase in value over time. However, the rental factor is normally <0.8%. These tend to be your high end properties. These properties might save you on your annual tax, but CGT will be payable when you sell the property.
A unicorn property is when you have the best of both worlds. Beware of the tax implication!
Property tax deductibles
As a property investor, you can deduct property expenses from tax. Bond interest, rates and maintenance can be deducted from your normal tax. If your investment property qualifies, you can deduct Section 13sex, 13quat or/and 13quin tax breaks.
Quick links
If you need help with rental property finances, contact me for a consultation. Let’s make your property investment a success!
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