What you need to know about the tax implications of principal residence

With so many South Africans working from home these days, it is tempting to claim home office space against business income when it comes to tax deductions.

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But few people realize that it can affect capital gains tax when they sell the house.

Just Property’s Sohail Govender outlines what you need to know if you sold your primary residence between March 1, 2021 and February 28, 2022.

To be considered a principal residence, your home must meet the basic requirements under SARS regulations:

• It must be a structure used as a place of residence by an individual.

• An individual or special trust must hold an interest in the residence.

• The individual having an interest in the residence, beneficiary of the trust, spouse of this person or beneficiary must usually reside in the house and use it mainly for domestic purposes as their habitual residence.

Believe it or not, a yacht, caravan or mobile home can be a principal residence if it is where the owners usually reside and it is used for domestic purposes.

If you own and live on a yacht and it is sold, you qualify for the principal residence exclusion.

What is the principal residence exclusion?

When taxpayers sell the house they live in daily, the first R2m of capital gain (or loss) is excluded when calculating capital gains tax.

The remainder of the capital gain will be subject to capital gains tax.

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The principal residence exclusion also applies to the land on which the principal residence is located, including adjacent unconsolidated land if the following conditions are met:

• The exclusion only applies to a maximum of two hectares.

• The land must be used mainly for domestic or private purposes with the residence.

•The residence must be alienated at the same time and to the same person as the land on which it is located.

All individual taxpayers receive an additional capital gains exclusion of R40,000 per annum.

How do you calculate your capital gains tax?

To calculate your net capital gain or loss, of which the first R2m can be excluded, take the proceeds (the amount for which you sold the property) and subtract the cost base (the original cost price paid for the property plus the improvements). If the property was purchased before October 1, 2001, check the relevant rules.

Assume that Mr A has sold his principal residence for R3 million, which he originally purchased for R1.4 million on October 1, 2001.

In 2008, he installed a swimming pool at a cost of R100,000. Its base cost is R1.4m plus R100,000, which totals R1.5m.

Subtracting the base cost of R1.5 million from the proceeds of R3 million, Mr. A’s capital gain is R1.5 million.

This falls under the exclusion (limited to the first R2m) and its capital gain/loss is nil.

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For assets that were acquired before October 1, 2001, the cost base is equal to the “measurement date value” of the asset, plus any other eligible costs incurred on or after that date.

How to calculate CGT when properties are in a condominium/marriage
If a principal residence is owned in a common domain / owned by spouses married in community of property, each spouse is treated as having equal shares.

For example, if a common estate sold a principal residence for R4m with a base cost of R2m, the capital gain is R2m.

Each spouse will have a capital gain of R1m, less the principal residence exclusion up to R1m each, meaning the gain included in taxable income will be nil for each party.

Declare home office expenses

If you work from home, claiming home office expenses on your tax return sounds like a great idea.

Think twice, as it could affect your capital gains tax when you’re ready to sell.

As Nicci Courtney-Clarke pointed out in her article for The South African Institution of Taxation:

“If the taxpayer worked from home and used part of the house as an office, the Income Tax Act requires that the capital gain be allocated between the use of the principal residence and the use of the business .

“This allocation should consider how long the home office has been used as part of the entire ownership period, as well as the size of the home office relative to the size of the entire property.”

Courtney-Clarke gives the example of a 100 m2 house bought for 1.2 million rand in February 2007.

A 10m2 home office was added in February 2015 at a cost of R300,000.

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Remember that the distribution is a percentage calculated according to the square meter of the part used for commercial purposes on a part of the whole house.

From 2015, the owner claimed 10% of the running costs of her house as a deduction from her taxable business income until February 2019, when she sold her house for R3.5 million.

His taxable income in 2019 was R500,000. The proceeds from the sale were R3.5 million. Its base cost was the initial purchase price of R1.2 million plus home office renovations of R300,000, which totals R1.5 million.

Capital gains plus proceeds of R3.5 million and cost base of R1.5 million total R2 million.

Part of the capital gains attributable to the use of the property as a home office (10% for four years out of 12 years): R2m × 4/12 × 10% = R66,666.

Part of the capital gains attributable to the use of the property as a principal residence: R2m minus R66,666 = R1,933,334.

Minus main residence exclusion: R1,933,334 – R2m = none. The total capital gains is R66,666. Minus the annual capital gains exclusion: R66,666 – R40,000 = R26,666.

“The capital gains inclusion rate is 40% for individuals. This means that 40% of the gains (R26,666 × 40% = R10,666) are added to the seller’s taxable income and will be taxed at their marginal tax rate,” Courtney-Clarke concluded.

Some interesting frequently asked questions:

• What if my primary residence was on a 99 year lease, but I have now sold that lease and made over R2.5m profit on the sale, will I still be able to apply exclusion?

Yes, the principal residence exclusion will apply, provided the individual has an interest in the residence. Interest means a real right and a right of use or occupation.

• What if the primary residence is in a Trust or Pty?

The principal residence exclusion will only apply if the property is owned by an individual or a special trust.

A Pty or corporation will not qualify as the corporation, being a separate legal entity, owns the property.

• We moved to our holiday home on Garden Route during the first lockdown. I spend the nights of the week in our house in Johannesburg and I return at the weekend.

My wife and children now live in the George house, but I spend most nights in the Johannesburg house. If we decided to sell the Johannesburg house, how would the capital gains be applied?

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The sale of the Johannesburg home would still benefit from the principal residence exclusion for CGT purposes.

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