In my previous article I talked about the possibility of some income tax relief that you may qualify for whilst working from home. This is particularly relevant given many people have little choice but to do so under the Lockdown. However, one needs to also be aware of the negative tax consequences of working from home. I have mentioned that there are VAT consequences but, since most employees are not VAT registered, I’ll leave that for another day. Another consideration relates to capital gains tax (CGT) and the primary residence exclusion.
Let’s first recap how the primary residence exclusion works: If you sell your home you will first need to calculate the capital gain using the normal capital gains tax rules. Simplistically, this involves taking the proceeds the less base cost. By way of example, let’s assume you paid R1 million for your home in 2005 and you now sell it for R3 million. The gain would be 2 million. You only need to include 40% of any gain in your taxable income but before you do that, provided your home is your ‘primary residence’ ie your main home/residence and the property is used mainly (i.e.more than 50%) for domestic purposes(let’s say 100% at this stage), you can reduce the gain by the R2 million primary residence exclusion i.e. you won’t have to include any of the gain in your taxable income. (If you had sold for less than R2 million then it would not even be necessary to do the calculation, but see below).
However, you may not have used the home only as a primary residence i.e. for domestic purposes. If, for example, you work from home (you have set up part of your home as an ‘office’ and use it exclusively for a trade purpose- employment is included in the definition of ‘trade’) and you have claimed expenses relating to, say, 25% of the home as relating to that work e.g. electricity, water, bond interest, rates, maintenance and repairs etc for income tax purposes over the years (or even just for the Lockdown period- now over 70 days), you will need to consider whether you can still claim the full R2 million primary residence exclusion when you sell your home.
Of importance is that the law relating to this exclusion talks about how the residence is “used”, not what claims you have made for income tax purposes (albeit that claiming those income tax deductions demonstrates clearly that the property has been used for purposes other than only domestic purposes). The exclusion is dependent on the period for which the residence was used or mainly usedfor domestic purposes and the portions of the residence that have been used for domestic and non-domestic purposes over that period.
So, what happens if you have used your house partly for trade purposes e.g. like in the example – 25% – for non-domestic purposes?
In this instance you have used your residence mainly (i.e. more than 50%) for domestic purposes so you do qualify for the exclusion. However, you have also used part of it for non-domestic purposes for a period. As a consequence, on disposal, the R2 million will need to be apportioned for the period of time and for the portion of the residence used for non-domestic purposes. This applies whether you have claimed any portion of the costs of the property as a ‘home office’ deduction for income tax or not. I would however, add that if, in the ordinary course of life, you have an office at your place of work but sometimes bring work home at night or over the weekends and work at the dining room table, dressing table or kitchen counter this should not result in you needing to do the apportionment as you are using the relevant space ‘mainly’ for other, domestic, purposes e.g. eating, doing your hair and make-up or preparing food, respectively, not your ‘trade’ i.e employment.
So, following on from the example above: You bought your home on, say, 1 March 2005 for R1 million and sold it on, say, 28 February 2020 for R3 million and used 25% of it for trading purposes for 5 years (this could just as easily be e.g. 90 days of Lockdown) during that period.
Although the law is by no means clear, and it is debatable as to how the apportionment should be applied, the CGT Guide issued by SARS (albeit not in much detail) advises that the following procedure should be followed:
Proceeds R3 000 000
Base cost R1 000 000
Overall gain R2 000 000
Portion of gain attributable to period when residence used exclusively for domestic purposes:
R2 000 000 x 10/15 = R1 333 333
Portion of gain attributable to dual use period:
R2 000 000 x 5/15 = R666 667
The dual use portion of the gain can then be split as follows.
Domestic use part of gain:
75% x R666 667 = R500 000
Non- domestic use part of gain:
25% x R666 667 = R166 667
Now that we have split the domestic and the trade use of the residence, we can determine what falls to be taxed.
Primary residence portion of gain:
R1 333 333 + R500 000 = R1 833 333
This part of the gain qualifies for the primary residence exclusion ie R2 million and thus. None of this portion is subject to CGT.
Business portion of gain:
= R166 667
This will be taxable since it is not covered by the primary residence exclusion.
If the R166 667 is your total (or aggregate) capital gain for the year, you may set off your R40 000 annual exclusion against it. The R166 667 is then reduced to R126 667 and 40% of this amount or R50 667 is added to your taxable income for the year.
The same principle applies if you have leased portion of your home out e.g a flatlet on the property or used some of it for Airbnb (after 1 October 2001). Again, you would have to apportion the exemption over the period that you did not occupy it.
However, there are special rules if you rented the property and you were away from home because you, for example, had to work elsewhere for a short period or if the residence was vacant for a short time shortly after you bought it or before you sold it, or it could not be live in temporarily e.g. due to repairs required following a fire. I will look at these scenarios in another article.
As you can see these rules are complex and they require a lot of information about the time you have lived in your home and what you have used it for, so good records are important.
Despite the fact that one of the basic tenets of tax is that it should be simple, these rules once again show that it is far from being so.