The introduction of capital gains tax has thrown up a number of interesting tax scenarios. Deborah Tickle, a tax partner at KPMG, looks at how CGT affects home improvements that you do yourself.
You are liable to pay tax on capital gains you make as a result of do-it-yourself work you do on an asset. The costs you incur to fix up an asset, such as a second home, and hence improve its capital value are deductible, but you cannot put a figure to your labour and deduct that from your capital gain.
A reader phoned me recently with the following post-October 1, 2001 scenario:
Through hard work, despite having paid all your taxes, you have built up some funds and are able to buy a second property as, say, a holiday home. It is run down and you decide to spend your weekends "doing it up" yourself. You go to the hardware store and buy the materials, and spend many hours getting the property to the state and condition you feel is acceptable.
In case you decide to sell that property in the future, you keep the details of all the costs you have incurred to buy the items you have used to improve the property. However, despite its increased value as a consequence of your hard work, the "base cost" of the property - that is the cost that you can use for capital gains tax purposes - does not take into account the value of your own "hard labour".
The reader suggested that it might be equitable for the South African Revenue Service to use one of two bases to determine the base cost of the property:
- An agreed rate per hour (our reader would record his hours); or
- A quote from a third party professional, setting out what they would charge to do the same work.
However, unfortunately for our reader, despite the many hours that he may have spent working on his property, CGT legislation does not cater for the "cost" of this work. It caters only for money actually spent.
The reader could have bought the property in another entity, such as a company or a close corporation (CC), in which case he could draw up an invoice for the work he has done to improve the property and this amount could be deducted from the gain the company or CC would have to pay. However, the amount reflected on the invoice (reflecting income the reader had earned) would then need to be included in his normal taxable income, and he would be taxed at normal tax rates immediately.
This might be somewhat more costly than the additional CGT payable as a consequence of not being able to account for the time spent in upgrading the property.
There is clearly a flaw in CGT legislation in this respect. Had our reader bought the property and made the improvements before the introduction of CGT, the full market value of the property, including the value of improvements (which would have taken his time, as well as the cost of the items he used into account) would represent the base cost of the property on the market value basis, on October 1, 2001.
But, as the courts have pointed out to us a number of times, since when has tax been fair?