Personal Finance has enlisted the help of Deborah Tickle, a tax partner at KPMG, to explain common tax problems. This week, she considers the debate about owning property, other than your primary residence, in a trust, close corporation or company.
Should you hold a second property in your own name, or in a company, or a close corporation (CC), or a trust? The property may be one you will use or rent out for holiday purposes, or a commercial property, such as a factory or office block.
Before you even consider the tax implications, it is important to look at the commercial aspects of this decision. For example, you should consider your personal risk profile and that of your existing company or CC: Do you want to expose the new property to any of those risks? Conversely, you must consider what the risk profile of the property will be. In addition, you must decide what your estate planning objectives are.
If you decide that you do not want the property to be exposed to your personal risk profile, because the risks are too great - perhaps you are running a business in your own name or have signed personal sureties and guarantees - it is important to remember that merely putting the property into a company or CC will not remove this exposure. Since you will hold the shares in the company, or membership in the CC, in your own name, if you are sequestrated, your shares or member's interest will fall into your estate and be taken away.
In addition, merely putting the property in a company or CC that is in your own name, will not necessarily be in line with your estate plan. For example, you may want to ensure that the property is only for the benefit your children, but not their potential spouses - particularly if their marriages fall apart. Merely bequeathing the company or CC to your children may not provide that protection, depending, of course, on their marriage contracts.
To minimise these commercial risks, you may need to consider putting the property into a trust or, to improve the tax efficiency, into a company that is owned by a trust (a CC may not be owned directly by a life or inter vivos trust). You should consider the set-up and annual audit costs of these two entities in relation to the potential tax savings.
What are the tax implications of these options?
If you buy the property in your own name, you personally will be taxed on the taxable profits generated by the property. For example, if you rent out the property, you will be taxed on the rental income received less any allowable expenses, such as interest payments on a home loan, rates and repairs. The rate of tax you pay will depend on your other income, because the taxable profit will be added to your other income and taxed at your marginal tax rate.
Your marginal rate is the rate of tax you pay on income you earn over a certain set amount. For example, if you earn taxable income of more than R220 000, the rate will be 40 percent.
Conversely, if the property generates a loss, this may be set off against your other income (provided the property has been rented out on a commercial basis).
If you sell the property, you will be taxed at the capital gains tax (CGT) rate applicable to individuals. After taking the annual R10 000 CGT deduction into account (only available to individuals), 25 percent of the gain will be added to your personal income and taxed at your marginal rate - a maximum effective 10 percent if you are on the top marginal tax rate.
For estate duty purposes, however, the full value of the property will be included in your estate, to be taxed (after deductions and the abatement - currently R1.5 million) at 20 percent.
If the property is put into a company or CC, the effect for estate duty purposes will be the same.
However, the profits you make from, for example, renting the property, will be taxed at only 30 percent - the income tax rate for companies or CCs. However, if you decide to take out the profits as a dividend, this increases the effective tax rate to 37.8 percent. If the property generates a loss, this may not be offset against your other personal income.
However, on selling the property out of the CC, the effective rate of CGT will be 15 percent on any gain. If the CC is then wound up or sold, you may be liable for CGT again.
If the CC owning the property is sold, the CGT rate will be the individual rate.
If your objective is to have an effective estate duty plan, or to protect the growth in value of the property from creditors, it may be better to use a trust. The trust may own the property through a company. The reason you need to have a company is to minimise the income tax and CGT rates, because without it, you would pay the tax rate applicable to trusts. The income tax rate at which the taxable profits of a trust are taxed is 40 percent. Any capital gain is taxed at 50 percent of the income tax rate - that is, 20 percent.
You should, however, remember that if a property is held by a trust and you provided the funds to the trust as a donation or an interest-free loan, you may still be taxed at your personal marginal rate on the income the property earns or any capital gain on it (even though you have no right to that income). However, for the purposes of estate duty, you will only be taxed on the amount of the loan.
Clearly, the affect of owning a property in your own name versus in a CC or via a trust can be vastly different from a tax point of view. You need to establish your commercial and tax objectives first and, based on those objectives, seek professional advice to ensure you make the right decision.