It may seem obvious that you should take advantage of the opportunity to transfer a property out of a company or a trust and into your name tax-free. But, as these examples show, this may not necessarily be the case.
Much has been written about the opportunity provided by recent legislation to transfer a residence held in a company, a close corporation (CC) or a trust into your own name tax-free. In this article, I look at some specific situations and the issues that you need to consider when contemplating this legislative opportunity.
In brief, this is the opportunity you have: you can transfer a residential property out of a company (for the purposes of this article, a company includes a CC) or a trust into your own name without paying transfer duty or secondary tax on companies (STC). Capital gains tax (CGT) is rolled over, or deferred, until you dispose of the property, and the base cost of the property when it was acquired by the company or trust becomes the base cost of it in your hands.
Existing legislation states that the transfer must take place between February 11, 2009 and December 31, 2011. In documents released with the latest Budget, however, the South African Revenue Service said it had realised that this window period is too short. It said a more flexible period would be announced shortly, but this had not been done by the time Personal Finance went to press.
The legislation applies only where all the shares of the company are held by yourself and/or your spouse, and where you and/or your spouse are living in the property. Alternatively, you must have donated the property or given it to a trust on a low-interest or interest-free loan account, or financed all the expenditure incurred by the trust to buy and improve the residence. In addition, you and/or your spouse must have used the residence mainly (that is, more than 50 percent of the property) for domestic purposes for the period for which you held it.
Let's look at an example to see what happens if you opt to keep the property in the company or trust, and, alternatively, if you decide to take advantage of the opportunity and then dispose of the property.
Let's assume that the property was acquired by the company or trust after October 1, 2001 (that is, after CGT was introduced), and had an original cost (with improvements) of R800 000, and that its current value is R4 million. You bought all the shares in the company in January 2002 for R850 000. You bought the shares, rather than buying the property directly, to avoid transfer duty (you paid stamp duty at 0.25 percent instead). You were very happy with the arrangement, because, shortly thereafter, legislation was introduced in terms of which you have to pay transfer duty on such a purchase of shares in a residential property company.
However, you did not factor in that if you were to sell your home now - that is, the company sells it or you sell the shares - you would not be able to take into account the primary residence exemption when determining the CGT. The primary residence exemption is R1.5 million if the proceeds from the sale exceed R2 million. Any capital gains can be ignored if the proceeds are R2 million or less.
I will also assume that your marginal tax rate is 40 percent, and that you have used up the annual exclusion (currently R17 500) on other capital gains.
If your company sold the property today for R4 million, it would pay CGT of R448 000 . The profit on the sale would then need to be transferred to you as a dividend, and the company would pay a further R250 181 in STC on that dividend.
If you took advantage of the legislative opportunity (assuming the company and property satisfy all the requirements), there would be no CGT in the company, because the property would be deemed to have been sold to you for its original cost of R800 000, and no STC, because there are no profits (for accounting purposes, your company would also sell the property to you for R800 000). Any loan you made to the company to help it buy the property would need to be repaid with the proceeds of the sale of the property to you.
If, thereafter, you sell the property to a third party for R4 million, the CGT would be R170 000 .
Contrast this to the R698 181 (R448 000 + R250 181) above and you will see that it is quite a large saving!
Care needs to be taken in making this decision to transfer the property out of the company if the cost of the property in the company is very much less than the cost you paid for the shares, because it is the base cost of the property in the company that is transferred to you. You may not use the base cost of the shares.
However, now that the benefit of buying a property in a company or trust has largely diminished, you may find it difficult to find someone who is willing to buy the company (in which case, you could use the base cost of your shares against the proceeds).
In addition, any intelligent purchaser would want to factor into the purchase price they would offer you the inherent CGT that would be paid by the company should it sell the property, and your proceeds would be reduced accordingly.
If the property is kept in a trust
Now let's look at the position if you have your home in a trust and you die without first transferring it into your own name, as opposed to if you do transfer it in terms of the legislative opportunity.
Assume that your children are beneficiaries of the trust, and that the trust is a vesting trust - that is, when any monies are earned, they vest in, and will be taxed in, the beneficiaries' hands. Although many trusts are discretionary in nature, I have used a vesting trust for the purposes of this article to demonstrate what happens when the income or gain is vested in the beneficiary immediately when it arises. In this situation, it makes no difference whether there is one beneficiary or multiple beneficiaries, except if they have different marginal tax rates.
Let's also assume the same values as before for the property and that the requirements of the legislation that provide the opportunity to transfer the property into your own name are satisfied. In addition, assume that you have other assets that amount to R3.5 million that will exhaust the estate duty exemption to which your estate is entitled on your death. Estate duty is levied at 20 percent of assets on death, but the first R3.5 million (or R7 million between couples) is exempt, as are any assets left to a spouse.
The question is: what happens when you die if a decision is made to rent out the property or, alternatively, to sell it and distribute the proceeds to your children? (If the property were left in the trust, the proceeds would already be distributed to the children, because it is a vesting trust.)
If the property is left in the trust, your death will have no impact on the tax inside the trust, provided that you leave any loans you made to the trust to your children and not to the trust (but that is the subject of a different article). Furthermore, no estate duty would be payable on the property.
However, if you lent the cost of the property to the trust on an interest-free loan account and none of it has been repaid, estate duty of R160 000 (R800 000 x 20 percent) would need to be paid in respect of the loan account that is included in your estate.
If the decision by the trustees is that, since you no longer occupy the property, it will be rented out, the rentals will, after the relevant expenses (rates, repairs and maintenance) have been deducted, be taxed in the beneficiaries' hands each year.
If, on the other hand, the property is sold, the gain made on the property will vest in the beneficiaries' hands, and each of them will pay CGT on their share of the distribution. CGT totalling R320 000 will be paid between them (assuming they each have a marginal tax rate of 40 percent and have used up the R17 500 of capital gains you are allowed to make each year without incurring CGT).
Thus, total tax of R480 000 (R160 000 + R320 000) will have been paid.
The total tax could be less if any of the beneficiaries has a marginal tax rate of less than 40 percent and if he or she has not used up the annual CGT exclusion. So if, for example, there were two beneficiaries and they have no other income at all, the gain would be split between them and taxed on the sliding scale for individuals. They would each pay R94 472.75 or a total of R188 945.50 in CGT . In addition, estate duty of R160 000 would be payable, making a total of R348 945 in taxes paid.
Estate duty versus CGT
If, however, you take advantage of the legislative opportunity before your death, no tax will be paid when the trust sells the property to you. The trust will repay your loan account with the proceeds. On your death, you will be deemed to have disposed of the property, and your estate will pay CGT of R170 000 on your behalf .
Your estate will also pay estate duty of R800 000 (R4 million x 20 percent) on the value of the property. Thus, total tax of R970 000 will have been paid. This is considerably more than if you had left the property in the trust. However, if you have no other assets, this amount could be reduced dramatically by the estate duty abatement of R3.5 million.
In this instance, your children would acquire the property at its market value (R4 million). If they chose to rent it out, they would pay tax on the net rentals (as is the situation if the property were left in the trust) or sell it for its market value of R4 million, and no further CGT would be paid. This is because the estate would have paid CGT on the deemed disposal at death. The children would have inherited the base cost of R4 million, and if they sell the property immediately for the same amount, there is no gain.
Clearly, if you intend to keep the property throughout your life, it may be worthwhile to retain the property in the trust, because the saving in estate duty may outweigh the additional CGT that arises if the property is sold from the trust on your death. You need to do some sums before making this decision, and it would be best if you did so with the help of a professional adviser.
Death taxes paid by a company
The above example relates to where the property is held in a trust. You should remember that a company held by you directly does not have the estate duty advantages of a trust, and estate duty will be payable on the full value of the shares (market value of the property less the loan account), even if you leave the property in the company.
The taxes that will be paid on your death are estate duty of R800 000 ; and CGT of about R315 000 . Your estate or beneficiaries may then also find that a further R698 181 (CGT and STC) is payable by the company in order to get the proceeds from the property into their own hands.
So it seems that if you hold the property in a company, as opposed to in a trust, it is generally always more tax-efficient to use the legislative opportunity to move the property out of your company and into your own name. Again, however, approaching a professional adviser to help you get the sums right would probably be a wise move.
- Deborah Tickle is a partner at KPMG.
This article was first published in Personal Finance magazine, 2nd Quarter 2010.