How is capital gains tax calculated for rental property?

When a property (or asset) is sold, you need to pay tax to the South African Revenue Services (SARS). When it comes to capital gains tax (CGT), the intention of the asset is very important. If the asset was bought with the intention to keep it for the long run, such as rental property, then CGT will be payable when sold.

How much rental income is tax free in South Africa? In this article, we will look at what is CGT, how the different legal structures is affected by it and how to pay less CGT.

What is capital gains tax?

The law governing and defining CGT in South Africa came into effect in October 2001. All individuals, trusts and companies need to pay CGT to the South African Revenue Service (SARS) when selling a property that has increased in value since it was purchased. There are however some exclusions that can be applied to primary residences – this being defined as a property that the owner lives in on a permanent basis. For the purpose of this article, we’re focusing on rental property.

SARS loves using big words to explain things, and due to the complexity of CGT, it’s worth understanding the following terms:

  • Asset – An asset is something that holds economic benefit for the posessor over a period of time. In personal finance terms, it’s anything you invest in over a period of time, with the aim of putting more money into your pocket.
  • Disposal – When you expropriate, sell, swap, get rid of or auction a rental property, it is seen as the disposal of assets. When you die, it is also seen as a disposal of the asset.
  • Proceeds – Proceeds are the thing that you gain from selling your rental property. Generally, this is money (ZAR or USD).
  • Base Cost – the base cost is the money you paid for the asset. For rental property, this will be the purchase price. There are other costs that can be deducted as well, to be discussed later in this article.

Remember that you don’t need to register for CGT, but forms part of your income tax.

So, let’s say you buy a rental property in 2005 for R 300 000 (the base cost). You decide to sell it in 2022 for R 400 000 (proceeds). SARS interprets the disposal of the asset as a taxable event and tax should be paid when the proceeds are more than the base costs. In short, the formula for capital gain is:

Capital gain = proceeds – base cost

The capital gain is taxable. You would had made R 100 000 gain (profit). If the property is in your own name, you get to minus R 40 000 as part of your annual exclusion, meaning only R 60 000 would be taxable capital gain that will be taxed.

Calculating the base cost of rental property

It’s quite easy to split pleasure and business when investing in other asset classes. Property, on the other hand, can get very complicated. For example, you can improve your property by renovating the kitchen, building an extra room or adding a swimming pool. Projects like this can raise the potential sale value of the property and therefore can be included in the base cost when selling the property

On the other hand, what would happen if you live in your rental property for 3 years, then rent it out for 5 – and then sell it? Well, you will need to calculate the time that the property was used as a primary residence and deduct that percentage from the taxable income.

For more information on specific scenarios, you can check out the SARS article for base costs.

What if my property was bought prior to the introduction of CGT?

If a property was bought prior to the introduction of CGT, SARS introduced a complex formula to determine how much you need to pay in CGT. It uses the time-apportionment method:

Original cost + [ (proceeds – original cost) x Number of years held before 1/10/2001] /
[Number of years held before 1/10/2001 + number of years held after 1/10/2001]

What is excluded from capital gains tax?

Capital gains tax is payable on rental property. There are however some exclusions on property that needs to be considered:

  • If you lived in the rental property for a period of time, then a portion of that would be deductible from CGT. Up to R 2 000 000 is excluded for your primary residence. If it is a joint bond, then the CGT is split between the two people
  • CGT on your secondary property is R 40 000.
  • If you own a property company, and you’re over 55 – the exclusion of R1.8 million when you sell (or dispose) of the property company. The proceeds should be less than R 10 million for this exclusion to be applied.
  • When you die – In that tax year, the exclusion for individuals is R300 000.

Factors you need to know when doing your CGT

There are three factors that are used to calculate the CGT:

  • Capital gain – As previously mentioned, this is calculated by this calculation: proceeds – base cost
  • Inclusion rate – Only a certain percentage of the capital gain is taxable. The inclusion rate is the part that is taxable.
  • Tax rate – Your tax rate is calculated on your total earnings for the year. Your tax rate is generally between 18-45%, depending on your income.

The calculation for calculating CGT is:

CGT = capital gain – exclusions x inclusion rate x your marginal tax rate

Remember that for all legal entities and individuals, you can deduct the bond and transfer costs, upgrades and enhancements as part of the exclusions.

How is capital gains tax calculated in South Africa for individuals?

When it comes to CGT, SARS tend to favour natural persons (individuals) compared to trusts and companies. If you, therefore, have the property in your own name, you will pay less CGT.

  • Every year, SARS gives you, the individual, the first R 40 000 tax-free – pocket it!
  • Only 40% of your ‘profits’ (capital gain – exclusions) is taxable

Understanding rental property capital gains tax for a company, trust or individual

Generally, in rental property you have to choose two of the following: liability, tax and income. If you favour tax, then having a property in your own name would be welcoming when selling. But if you favour limited liability, then a company might suffice.

  • The capital gains of trusts and companies are fully taxable.
  • 80% of company capital gain is taxable

What is the maximum capital gains tax I will pay?

The 2023 rate for individuals is a maximum of 18%, companies 21.6 % and 36 % for trusts. for those interested, we can see below an annual breakdown of CGT (from SARS) over the last few years:

​Type2023​2022​2021​2020​2019​2018​​2017​2016​2015
​Individuals and Special Trusts18%​18%​​18%​18%​18%​18%​16.4%​13.65%​13.32%
​Companies21.6%​22.4%​​22.4%​22.4%​​22.4%​22.4%​22.4%​18.65%​18.65%
​Other Trusts36%​36%​36%​36%​​36%​36%​32.8%​27.31%​26.64%

What if I work overseas and sell a property?

When you work overseas, you need to determine if you’re a tax resident of South Africa. If yes, then you will need to pay tax locally. If you are considered a non-resident for tax purposes the sale of your property will be subject to a potential withholdings tax in South Africa. The attorney/agent will be forced to withhold the taxable amount.

Non-residents will pay a withholding tax when selling their property. The following percentages of tax is used:

  • 7.5% of the sale price if the seller is an individual
  • 10% of the sale price if the seller is a company
  • 15% of the sale price if the seller is a trust

How does tax work when flipping properties?

SARS is very much interested in your intention when buying an asset. If you’re buying the property with the intention of holding it for a long-term investment (such as rental property), then you will need to pay CGT on your proceeds. If your intention is to fix and flip a property – then you will be taxed at your normal tax rate, and not pay capital gains tax.

If you’re trading as a company (a pty ltd), then you will be taxed at 28 % on all profits.

How much rental income is tax free in South Africa? It depends on your income bracket. The tax rates for individuals for the financial year 2022/2023 are below:

​Taxable income (R)​Rates of tax (R)
1 – 226 00018% of taxable income
226 001 – 353 10040 680 + 26% of taxable income above 226 000
353 101 – 488 70073 726 + 31% of taxable income above 353 100
488 701– 641 400115 762 + 36% of taxable income above 488 700
641 401 – 817 600170 734 + 39% of taxable income above 641 400
817 601 – 1 731 600239 452  + 41% of taxable income above 817 600
1 731 601 and above614 192 + 45% of taxable income above 1 731 600

Conclusion

Tax is only one of the three considerations in rental property strategy (liability, tax and profitability). Make sure that your legal structure suits your rental property strategy. If your focus is on lowering your taxable income, then it might be good to have the property in your own name to pay less CGT but doesn’t give you limited liability.

Capital gains tax is payable when disposing of assets where the intention was one of investing, rather than day-to-day income. To calculate how much capital gain you will need to pay when selling your rental property, you can use the following calculation:

CGT = capital gain – exclusions x inclusion rate x your marginal tax rate

Please make sure you use the above inclusions and exclusions, depending if you’re a company or individual.

Happy investing!

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