For quite some time, buying property using borrowed funds with a view to renting it has not been an investment filled with prospects of large profits on the rental income, at least not for the first few years.
And as interest rates increase this prospect diminishes. So if you own, or are buying an investment property, the chances are you will lose on the investment for the first few years.
However, can the blow of the increased interest rates be reduced by deducting this loss against your other taxable income, thereby reducing your tax bill?
The answer, at first sight, would appear to be yes. But, beware, there are some pitfalls.
There have been several cases over the years where taxpayers were not allowed to deduct their rental loss against their other income. And the South African Revenue Services (SARS) has considered itself to have been lenient in these cases, since it has disallowed only the loss and not the entire amount of the expenditure!
The arguments used in the cases revolved largely around the requirements that, for expenditure to be deductible, it must be incurred to produce income, and it must also be spent for the purposes of trade.
So why did the taxpayers fail, and what lesson can you learn?
In the first case, a man bought a holiday cottage for his own and his family's use, but let it out occasionally to other people and earned some rental income.
The expenditure incurred to own the cottage was considered by the SARS to have been spent for the taxpayer's holiday purposes and not for renting out and earning income.
The court felt that the taxpayer had little hope of earning a profit in the years under review, and did not allow him to deduct the excess costs over the income received.
On a brighter note, the court ruled in favour of a taxpayer who bought a rent controlled property with a view to using it as an investment which would provide rental income for his retirement. The taxpayer could, in this case, deduct all expenses, which resulted in a loss which he was able to set off against his other income.
The basis of the decision was that the taxpayer was able to show that he would, within about five years, derive profits from his investment.
So if you buy a property with a view to renting it out, it must be seen that that is the primary reason why you bought it and that renting it out is not merely a way of recovering some of the costs.
It is also important to show that it is possible for the property to generate taxable income in the future. If this is the case, then you should be able to prove to the SARS that the property is being used to generate income. On this basis, if a loss is initially experienced, the SARS may allow its deduction against your other income.