It sounds easy, a profit is taxed while a loss leads to a refund. Unfortunately, not! Where a rental property makes a profit, an individual has to assess the profit of the trade between March – August and pay an estimated amount of provisional taxes to SARS. This is repeated during February and any over-payment is refunded to the taxpayer while any underpayment could be subject to a penalty of up to 20% of the amount underpaid as well as interest.
A loss against a rental property is often challenged by SARS to firstly, verify that such transaction is indeed a trade (not presented as a trade but in reality, maintenance of a relative or friend) and that the trade is profitable or is likely to be profitable in a reasonable period of time. The reason, if there is no expectation of making a profit, then there is no trade and a loss may be denied on grounds that no trade exists.
Some people purchase a property, bond it and place a relative in that property charging a small amount of rental and then trying to claim a loss when filing their income tax return. The loss would of course be large and probably under audit as rental properties has SARS full attention. A questionnaire may follow asking many questions which a taxpayer has to answer. Bottom line is that some rental properties do not conform to the definition of a trade which has an intent of profit making. An understatement penalty may be imposed by SARS in addition to rejecting all expenses.
Where the transaction is a genuine trade, SARS may still question the loss and even disallow some expenses. One such example is where a person claims a repair which is an improvement, and which does not qualify as a deduction. Other individuals will try and claim the full bond payments made to the bank which is inclusive of interest (a revenue-based expense) and capital repayments (a capital in nature expense which is not allowed as a deduction)
In other cases, some taxpayers withdraw funds from their access bond and use the funds for a personal reason causing a higher interest expense which SARS rightfully may deny during an audit. (One may only deduct the cost incurred in the production of income and the burden of poof of an amount qualifying as a deduction is on the taxpayer. If the taxpayer could show workings of the portion of interest that remains a business expense and that of a private expense, the business portion may be deducted.) It does not matter if funds were injected into an access bond and then taken out again. Such withdrawal must be employed against the property to qualify under the criteria as an expense incurred in the production of income.
Lastly, if a taxpayer is on the top tax margin (45%) before taking into account the trade, SARS may impose Section 20A and ring-fence the loss against the other income. This means that the loss is not allowed as a deduction during that year of assessment but may be used to offset future profits. Again, this can become complex and one must make sure that losses are carried forward to the next assessment each year. (And that the correct amount is carried forward)
If a taxpayer could overcome all these hurdles, the loss against the rental property may be deducted against their income.
Fees paid to a tax practitioner may also be deducted against this income. Any bad debts or provision for bad debts may also be deducted against this trade income providing the amounts were included as income before and could be proven.
Rental properties can become complex or could be straightforward but should always be declared when an income tax return is filed to SARS.
Lastly, when selling a rental property, remember to build a file for the capital gain that must be declared to SARS with the capital gains trigger point being the date of transfer.