Capital Gains Tax

Author:  Tax Tim
Posted under Guidlines

What is Capital Gains Tax and How is it applied:

Capital Gains Tax was introduced on 1 October 2001. It forms part of normal income tax and is based on the sliding tax tables for individuals. It comes about most often for taxpayers when their home or investment property is sold for a profit (gain) i.e. the proceeds/selling price is more than the “base cost”.

The “base cost” is the purchase price plus any amounts spent on renovations or improvements, plus a few other smaller costs.
When you buy and sell your home, there are lots of bills to pay like lawyer’s fees, estate agent’s commission and compliance certificates for example. Knowing which costs to take into account when working out the proceeds and base cost can be complicated! Look at our Capital Gains Tax Calculator for more detailed advice on this.

This profit (or capital gain) is taxed at a lower rate than normal income – because only a portion of the capital gain (currently 40%) is included in taxable income, and not the full profit. So, selling your investment is not taxed at the same rate as money you earn from your salary, thank goodness!

This may sound concerning, but the Tax Act does provide a R2 million “primary residence exclusion” for those taxpayers who sell their primary residence (i.e. the home in which they live). This means that the first R2 million of your capital gain is exempt from tax, meaning that most taxpayers won’t actually need to pay Capital Gains Tax on the sale of their home.

It’s important to know that Capital Gains Tax doesn’t apply when you sell personal use assets. So, there’s no need to declare the details of your recent car sale or washing machine to the tax man!

Selling your primary residence

In this example, the R2 million primary residence exclusion would apply. If your home is sold for a gain (i.e. proceeds minus base cost) that is less than R2 million, the sale will not attract Capital Gains Tax.
Example 1:
Paul buys a home for R2 500 000. He spends R400 000 renovating it, and then sells it for R4 000 000 a few years later.  Paul lived in this house for the whole time that he owned it and therefore it would be regarded as his primary residence for tax purposes.

Excluding the capital gain, Paul’s taxable income for 2019 is R500 000.
The capital gain calculation for the tax year of 2019 is:
Base cost = R2 500 000 + R400 000 = R2 900 000
Proceeds = R 4 000 000
Capital gain = R1 100 000 (i.e. R4m – R2.9m)
Less: primary residence exclusion of R2 000 000
Taxable capital gain = nil

You can also use TaxTim’s handy Capital gains calculator to do the calculations for you.

Because the capital gain on Paul’s primary residence is less than R2 million, the entire gain is exempt from capital gains tax and he doesn’t have to pay any. 
Remember that every individual taxpayer also has an annual capital gain exclusion of R40 000 which needs to be taken into account first when figuring out the final capital gains tax that will be owed.

Selling your investment property

If you sell a property which is not your primary residence (i.e you own it and rent it out), you can’t apply the primary residence exclusion to this gain. This means that if your gain is greater than the annual exclusion of R40 000, it will attract capital gains tax.

Let’s look at the same example again but assume now that Paul has never lived in the house that he bought. He rented it to a tenant while he lived in a nearby property with his girlfriend i.e. he bought the house purely as an investment.

Example 2:
Base cost = R2 500 000 + R400 000 = R2 900 000
Proceeds = R4 000 000
Capital Gain = R1 100 000 (i.e. R4m – R2.9m)
Primary residence exclusion will NOT apply.
Taxable Capital Gain = R1 100 000 – R40 000 (annual exclusion) = R1 060 000

The inclusion rate for capital gains is 40% for individuals.
Capital gain inclusion in taxable income = 40% x R1 060 000 = R424 000
Paul’s taxable income = R500 000 + R424 000 = R924 000
Paul’s marginal rate of tax is 41% so he will pay approximately R173 840 capital gains tax. (You can work this out by taking R424 000 x 41%)

Selling your primary residence, which you rent out for a period
The above two examples are clear cut, so the capital gains tax calculation is quite simple i.e. it’s either your primary residence, or it’s never used for that purpose.

But what if you originally used it as your primary residence, but then moved out later and rented it to a tenant? Or, you first rented it out and then used it as your primary residence afterwards? This is the situation many confused taxpayers face, and they want to know how this affects the capital gains tax they need to pay when their property is sold.

The answer? The capital gain on the sale needs to be apportioned between primary residence use and non-primary residence use. The R2 million primary residence exclusion is applied to the portion of the gain, which relates to the primary residence use only. This means that you will need to pay capital gains tax on the remaining portion of the gain.

Let’s look at the same example again, but assume now that Paul lived in the house for five years and then relocated to a different city for three years, during which time he rented out his house. He then sold it eight years after buying it.

Example 3:
Base cost = R2 500 000 + R400 000 = R2 900 000
Proceeds = R4 000 000
Capital Gain = R1 100 000 (i.e. R4m – R2.9m)
Primary residence = 5 years
Non-primary residence = 3 years

Portion of the capital gain attributable to the property’s use as a primary residence:
5/8 x R1 100 000 = R687 500
Less: R2m Primary residence exclusion = nil capital gain

Portion of the capital gain attributable to the property’s use as a non-primary residence:
3/8 x R1 100 000 = R412 500
Primary residence exclusion will NOT apply.
Taxable Capital Gain = R412 500 – R40 000 (annual exclusion) = R372 500
Capital gain inclusion in taxable income = 40% x R372 500 = R149 000
Paul’s taxable income = R500 000 + R149 000 = R649 000

Paul’s marginal rate of tax is 39%, so he will pay approximately R58 110 capital gains tax.

As you can see from the examples above, the amount of capital gains tax payable varies widely depending on what you’re using the property for. There was no tax payable when it was used only as a primary residence, R173 840 payable when it was not used as a primary residence at all, and R58 110 to pay when it was used for some of the time as a primary residence and rented out for the rest of the time.

Original article:  view here