Have you fallen into a rental loss tax trap?

What Sars will and won't let you do if you're a landlord - tax expert.

Section 20A of the Income Tax Act provides that under various circumstances rental losses will be ringfenced, meaning that if a taxpayer makes a rental loss, he or she may not set off that loss against any other type of income e.g. salary. Guest columnist and Tax Partner at Cameron & Prentice Chartered Accountants, David Warneke explains.

The section is quite intricate. The circumstances under which it will have this effect are the following (all the bulleted circumstances must apply before it will take effect):

  • If the rental activities are carried on by an individual. The section does not apply to juristic persons e.g. companies, close corporations or trusts;
  • The individual has to be on the maximum marginal tax rate, ignoring the rental loss i.e. for the 2009 tax year, before taking the rental loss into account, he or she must have taxable income of at least R 490 000;
  • If counting tax years from the year ended 28 February 2005 onwards, the taxpayer has made rental losses for at least 3 of the past 5 years. For example: if a taxpayer declares a rental loss for the 2005, 2006 and 2007 tax years, the 2007 loss will be ringfenced. The same unfavourable treatment would apply to the 2008 and 2009 tax years if they showed rental losses. However where the rental comprises the letting of residential accommodation let to ‘relatives' of the taxpayer the 3 out of 5 year test outlined above does not apply and the loss is automatically ringfenced (from the 2005 tax year). For the purpose of the section the term ‘relative' means a spouse, parent, child, stepchild, brother, sister, grandchild or grandparent. More precisely, the section will automatically apply ‘unless at least 80 percent of the residential accommodation is used by persons who are not relatives of that person for at least half of the year of assessment.'

The taxpayer will be able to circumvent Section 20A if he or she can show that there is a ‘reasonable prospect' of deriving profits within a ‘reasonable period', given various criteria listed in the section. This would presumably provide an escape where the taxpayer purchases a property using 100 percent bond finance and would typically incur losses for the first five tax years, before breaking even.

However, where the losses run into a sixth consecutive year, the loss will be disallowed in year 6 as this escape is not available to any taxpayer who incurs rental losses for at least 6 out of the last 10 tax years (counting only tax years from 2005 onwards).

About the Realestateweb guest expert: David Warneke is tax partner at Cameron & Prentice, a Senior Lecturer in Tax at UCT and co-author of a text that is used at most universities throughout South Africa.

Disclaimer: This article does not constitute individual advice. You are urged to consult a professional in connection with your own transactions.

Article by: David Warneke - www.sapropertyinvestor.co.za