Vehicles For Purchasing Residential Property

Vehicles For Purchasing Residential Property

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In our modern world, in property, like many other areas, we are very often spoilt for choice. Choice is always good, but it sometimes makes it difficult to make a decision, especially if we aren’t fully au fait with the various options.

Prospective real estate purchasers often agonize over whether they should buy immovable property in their own name or in the name of a company, a close corporation or a trust.

In order to answer this question, the starting point is that you should generally look at the type of property which is being purchased. As an example; is the property going to be used for residential or farming purposes; is it being bought for investment purposes or for property speculation; is the property going to be developed; or is the property going to be your primary residence (the main living place) of the purchaser? In this article we will deal only with residential properties.

As a general rule you should never purchase residential property in the name of a company or a close corporation unless you are a developer or a speculator i.e. someone who trades in or intends to trade in property.

For most folks residential property should, generally speaking, only be purchased in the name of a natural person (whether it be a partnership or an individual) or a trust. We will examine the various entities separately below in a little more detail.

Buying Property In Companies And Close Corporations
Before the 1st of December 2002 it made sense to buy immovable property in the name of a company or a close corporation, mainly due to the fact that when you wanted to sell the property you could instead sell the shares or the members’ interest as the case may be, and the purchaser wouldn’t have to pay transfer duty.

This meant that either the property could be sold for more, as the purchaser was saving on transfer duty, or it would be easier to sell the property due to the saving which the purchaser would be making on transfer duty. In other words, a purchaser would rather buy a close corporation or company that owned the property and not pay transfer duty than buy the property and pay transfer duty which meant that the seller which was selling the close corporation or company was at a competitive advantage over a seller who was selling the property.

However, SARS closed this loophole by declaring that from the 1st December 2002 whenever a person sold the shares in a company or the membership interest in a close corporation which owned immovable property, such shares or membership interest would be deemed to be immovable property, and therefore transfer duty would be payable on the transaction. From this date a purchaser of the shares or membership interest did not save any money on transfer duty and in reality it became a huge disadvantage to purchase shares in a company or the members interest in a close corporation which owned residential immovable property as the purchaser would be taking over the risk of any hidden debts in the company or close corporation and ultimately would pay more tax.

Many Purchasers tried to overcome the first problem (the taking over of hidden debt) by stating that the Seller warranted that there were no liabilities other than those which had been disclosed to the purchaser. 

However, a warranty is only as strong as the person who gives it. As an example, if I were to give a warranty that I would pay one hundred million rand if the sun shone tomorrow morning, the warranty would be of no value as I most certainly could not pay one hundred million rand. 

To make it worse the purchaser would effectively be taking over the “pent up” tax in such close corporation or company. In other words when the close corporation or company eventually sold the property the company or close corporation would have to pay capital gains tax.

This tax would be calculated on the purchase price paid by the company or close corporation for the property and not on the price paid by the purchaser for the shares or membership interest which would invariably be much higher than the price which the company or close corporation paid for the property. This would mean that the purchaser would effectively through the company or close corporation be paying tax on profits which the company made but that he did not actually realise because he had bought the shares or members interest at a higher price.

For example if the selling price of the property were a million rand, the purchaser had bought the shares for R500 000.00 and the company had bought the property for R100 000.00, the tax would be calculated on R1 000 000.00 – R100 000.00 (the purchase price paid by the company) i.e. R900 000.00 and not on R1 000 000.00 – R500 000.00 (the purchase price paid by the purchaser for the shares) i.e. R500 000.00.

This would mean in the example given that the capital gains tax was payable on an extra R400 000.00.

To make matters worse a company or close corporation would pay a higher rate of capital gains tax than an individual namely 18.67%and then to add insult to injury any amount which was distributed to the owner of the shares would attract dividends tax of 15%. For this reason alone it would make no sense whatsoever to purchase residential property in the name of a company or close corporation or to purchase the shares of member’s interest in a company or close corporation which owns residential immovable property.

In addition, if the person was living in the house, in other words it was his or her primary residence, the person would pay capital gains tax on the full profit whereas if the property had been registered in his or her personal name they would have not paid capital gains tax on the first R2 000 000.00 profit.

It is therefore clear that it isn’t wise to buy a residential property in the name of a company or close corporation if one is buying such property for investments purposes or to live in.

Buying Property In Trusts
There are a number of advantages of buying a property in the name of a trust. These include the fact that a trust protects you to a degree against insolvency and you can also save money on estate duty particularly if your estate is worth more than R3 500 000.

Buying Property As A “Natural Person”
It also makes sense for a natural person either on his or her own or in partnership with other natural persons to purchase residential property in his or her name. When the property is the person’s primary residence (a person’s normal home) it would generally be wisest to purchase the property in the name of the individual due to the fact that the first R2 000 000.00 of the capital gain is exempt from capital gains tax and due to the fact that properties which are sold for R2 000 000.00 or less do not attract capital gains tax.
 
Should I Buy My Residential Property In My Name, In The Name Of A Trust Or A Close Corporation Or A Company?
The question arises whether you should then purchase a property in the name of a natural person (whether an individual or partnership) or a trust or a close corporation or a company. The factors which you should take into account include whether the property is the person’s primary residence, tax implications and the possibility of the person going insolvent.

If you are purchasing your primary residence (a place where you will be living) it would generally make more sense to purchase the property in your own name. The reason for the same is that the first R2 000 000 the capital gain on a primary residence is exempted from capital gains tax. A property only qualifies as a primary residence if it is owned by a natural person and therefore a trust does not qualify for this exemption.

In regard to other properties where the buyer is not a developer or speculator, it is difficult to decide whether it is better to buy the property in the name of a natural person or in the name of a trust.

A trust has a number of advantages in that a trust protects you against insolvency and also can result in a saving on estate duty.

The saving in estate duty arises from the fact that the assets which belong to a trust do not fall into your deceased estate. Accordingly this means that the estate is not taxed on any assets which belong to the trust. As the first R3 500 000.00 of an estate is not taxed in any event, the decision in regard to purchasing a property in the name of a trust or in the name of a natural person would often depend on whether the total assets of the relevant person exceeds R3 500 000.00 or will in the future exceed R3 500 000.00 or whatever amount will be exempted in the future. If so, it would probably make more sense to buy the property in a trust if you were going to hold the property indefinitely.

You should also assess whether there is any likelihood of a person going insolvent in the future. People who run a business may be more likely to buy the property in the name of a trust as the risk of going insolvent is greater. However, any person could in fact go insolvent even though people generally think it will never happen to them. For example, if a person has a motor vehicle accident and is hospitalized for a year he may well find himself in an insolvent position even if he has a good stable income and good stable job.
 
Another consideration is that an individual pays capital gains tax on a sliding scale of between 0 and 18.67% depending on the individual’s taxable income in the relevant year of assessment. A trust pays capital gains at the rate of 26.67% which would imply that it makes more sense to buy the property in the name of an individual from this aspect.

However, you are entitled to distribute any profits which are made by a trust to the beneficiaries and such amounts will be taxed at the tax rate governing such beneficiaries which means that the tax payable can be drastically reduced. Of course such profits once distributed would no longer form part of the trust assets and this would to a certain extent negate the advantage of having assets in a trust.

If you are purchasing the property for speculative purposes or if you are a developer it does not normally make sense to purchase the property in the name of a natural person as it could create a situation where such natural person is declared a trader in property and will then have difficulty persuading SARS that these investment properties should not be taxed on an income tax basis but rather on a capital gains tax basis. (Income tax is generally higher than capital gains tax). Under these circumstances you can either use a company, close corporation or trust.

Developers and speculators usually use a close corporation or company as the tax calculation would not be a major factor due to the fact that profits which are made would be taxed on an income tax basis and not on a capital gains tax basis. This means that the problem of paying a higher capital gains tax rate than an individual and of paying dividends tax is negated as the dividends tax and income tax paid by the company and close corporation will often nearly be equal to the tax rate of the individual.

The question which arises is whether instead of using a company or close corporation you should instead make use of a trading trust as the vehicle which owns and develops the property in a case of a developer or makes the profit in the case of a speculator.

For a company or close corporation the tax rate will be 28% with a 15% tax on any profits which are distributed. For a trust the profits will be taxed at 40% but again the profits can be distributed to the beneficiaries at their tax rate. Accordingly one would have to determine the financial status of each of the beneficiaries and of the parties before making a decision as to which vehicle would be the best vehicle from the point of view of tax.

With the new Companies Act now in operation, a party may decide to rather use a business trust rather in a company or close corporation because of the fact that the members of the close corporation and the directors of a company can be held personally liable if the company or close corporation is found to be trading in a position where it does not pass the liquidity test.

Summing up therefore you would generally utilize a company, close corporation or a trading trust if you were a developer or a speculator and you would generally buy residential property in the name of an individual or a partnership or a trust if you were buying residential property and generally speaking in the name of an individual if such residential property were the person’s primary residence..

* Can be distributed to the beneficiaries. ** The first two millions Rands capital gain is exempted if it is the primary residence.

Note that companies, Close Corporations, trusts and individuals all pay the same transfer duty.

Author: Barry Davies