By Dominique Bowen
For many, buying a property to let has long been and continues to be the obvious smart choice when looking to invest. Our ears prick up at the mention of “passive income”. Who couldn’t do without an additional stream of inflation-beating income on an asset that, if carefully chosen, can appreciate in value too? These are just some of the perks of property ownership, but it’s important not to put all your eggs in one basket. As Monica Moodley, legal adviser at Old Mutual, notes, diversification in an investment portfolio is vital to any financial plan. “This should include a variety of asset classes, such as cash, bonds, equities and property,” she says.
Perks and drawbacks of property
In addition to being a growth asset that can be passed on to beneficiaries on death, property can also help in lowering your portfolio’s volatility, says Moodley. But before you get swept up in the idea of signing a deed and watching the returns flow in, consider some of the possible drawbacks.
For one, property is a fixed tangible asset, which means it could be an obstacle to liquidity if you need to get your hands on cash urgently. Moodley adds that, just like any other investment, there’s no guarantee that the property you own will increase in value, or that you will make a profit upon sale. Sobering considerations indeed.
And then there’s tax…
It often catches buyers unaware, yet tax should be front of mind if you’re going to make a property investment work. Moodley discusses three ways in which property tax can work. These depend on whether you’ve purchased in your personal capacity, as a company, or in a trust.
Personal ownership
If you earn rental income directly as the owner of the property, the net amount after allowable expenses is added to your personal taxable income. Your tax liability is calculated in line with the SARS income tax table. There is a possibility that this can bump you up into a higher tax bracket, so this is something to watch out for.
Using a trust
Some investors set up a trust to house a family property portfolio and to protect assets. If you go this route and buy property in the name of a trust, the capital growth of the property takes place inside the trust, while the loan account that has been created in respect of the property is included in your estate. “A potential advantage of purchasing property in the name of the trust structure is that income that the trust generates may be accrued to the beneficiaries of the trust under Section 25B of the Income Tax Act,” says Moodley. “This income is, therefore, taxed in the hands of the beneficiaries (the conduit principle). If they fall in a lower tax bracket, this could effectively lower the net tax liability payable on the rental income.”
Using a company
If you use a company as a structure in which to grow your property portfolio, think about your current personal income tax rate and how this compares to corporate tax rates. It may not make financial sense for you to receive rental income as a shareholder’s dividend from your registered company, because the effective tax rate on that income could come in at around 40% after corporate tax and dividend withholding tax are deducted. However, if you fall into a higher personal income tax bracket, it could be worth exploring.
Easing your tax burden
As Moodley says, any property owner must effectively be able to satisfy SARS that they are carrying on a bona fide trade with the rental of their property. “The rental income you receive should be added to any other income; however, it can be reduced by certain permissible expenses that have been incurred during the period that the property was let,” she says.
These include:
- Rates and taxes
- Bond interest
- Advertisements
- Agent fees
- Homeowner’s insurance
- Garden services
- Repairs and maintenance
- Security and property levies
It is important to note that if only a portion of the property is rented out, any permissible deductions allowed should be proportionate, says Moodley. So, if you’re not renting out 100% of the property, you can only get deductions for the portion that has been rented out.
What about renovations?
“Improvements should not be confused with repairs and maintenance,” notes Moodley. They are two different aspects. Improvements are not regarded as an allowable deduction, whereas repairs and maintenance are.
However, improvements are advantageous when it comes to disposal of the property. You can lower your capital gains tax liability because the value of any improvements is added to the base cost (the price you originally paid), which is deducted from the selling price and then taxed, taking into account any tax exemptions that apply.
PERSONAL FINANCE