plan4cgt - Primary residence - Period apportionment exceptions

Higher level topic - Introduction and summary of when taxable.

Higher level - misconceptions; what is a primary residence

Level above - Apportionments - period;usage;size;joint owners

Also at this level - - usage and land apportionment exceptions; trade; repairs; ordinarily resident.

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This page - Period apportionment exceptions; new residence; erection; destruction and death.

 

 

Primary residences, exceptions to general apportionment propositions

Period apportionment exceptions

The general rule is that you, or your spouse, have to occupy, (or have occupied), a residence as the main residence for the primary residence exclusion to apply in whole or in part. Furthermore, there is the rule that only one residence may be a primary residence at any one time. There are exceptions to these rules.

The exception to this period apportionment rule is - An owner of the interest in a primary residence will be regarded as having been ordinarily resident in the residence for a continuous period, (not exceeding two years), if that person did not reside in that residence for any of the four reasons-

  • It was offered for sale and vacated due to the acquisition or intended acquisition of a new primary residence. (Provided that at the time it was the primary residence.)
  • The residence was being erected on land acquired for the specific purpose of erecting a primary residence.
  • The residence was accidentally rendered uninhabitable.
  • The death of the owner.

Regarding these exceptions-

It is important to remember that what these exceptions strive to provide for is continuity of the ordinary resident principle. (The language used in the legislation may not achieve what it sets out to achieve.)

The exceptions set out above override the only one primary residence rule.

The first of the four exceptions that allow for continuity of the period of ordinary residence, is where the residence was offered for sale and vacated due to the acquisition or intended acquisition of a new primary residence. (Provided that at the time it was the primary residence.) Let’s try some examples-

This example comes from the draft “Comprehensive Guide To Capital Gains Tax” as published by SARS.

In our view this example has some faulty logic that can be used to the advantage of the taxpayer-

Xolani is transferred from Knysna to Cape Town and she puts her house on the market. She struggles to sell it but in the meantime she buys a house in Cape Town. Eventually, some eighteen months later she sells it.

SARS is quite happy that this situation qualifies and that no apportionment is necessary. Furthermore, both residences will be regarded as primary residences at the same time.

Here is one of our examples - You are transferred from Jhb to Cape Town so you put your house on the market. You have no intention to acquire a home in Cape Town immediately as you need to see how the job turns out and house prices are in any event way beyond your reach. You rent a house in Cape Town in the meantime. It turns out there are great difficulties in effecting the transfer of the residence and the original ‘buyer’ eventually reneges on the deal. In one and a half years time the disposal takes place. You still cannot afford a house in Cape Town.

You vacated and sold, therefore it looks like you will be regarded as ordinary resident in that house for the one and a half year period. However, there is a requirement that it was vacated and sold due to the acquisition of a new primary residence. On the face of it, it looks like you will not be able to count that one and a half year period into the period of ordinary residence.

There is hope though! The acquisition of an interest in a residence includes a lease. There is scope for arguing that the lease was an acquisition of a new primary residence and in any event, why should the legislation discriminate against the poor?

However, there could be a fault in this argument! There is a possibility that it wont succeed.

Let’s put some numbers to this to assess the impact. We will take a few shortcuts on the assumption that the period apportionment is now familiar territory-

You acquire a primary residence for R400 000 on 1 October 2001, you occupy it for two years. You move down to Cape town. The residence is disposed of one and a half years later for R600 000. 

On the assumtion that the one and a half year period qualifies

    The capital gain is R200 000. As the house has been treated as being occupied during the entire period from 1 October 2001 to the date of disposal there will be no period apportionment. The entire gain qualfies for the primary residence exclusion and there will be no CGT effect.

On the assumption that that period does not qualify-

    The capital gain is R200 000. The relevant period of ownership is 42 months. For 24 months it was occupied as a primary residence. Therefore the primary residence exclusion will be R200 000 x 24/42 = R114 285. The difference between the R200 000 capital gain and the R114 285 exclusion, (being R85 715), will be subject to CGT .

Another example - You are transferred from Jhb to Cape Town and you immediately put in an offer for a home in LLandudno. The offer is accepted but you are not in a position to sell your home in Jhb as your son has to finish his final exams at university, and you don’t want to uproot him. You put your house on the market two months later.

In this case the timing is out! The relief is offered when you sell the property and vacate it due to the intended acquisition of a new primary residence. There may be some hope though!

It could conceivably be argued that you sold and vacated it due to the acquisition of a new primary residence. The sell side of the picture looks a little tenuous, however, could it be that you always intended to sell it, that you couldn’t possibly afford the home in LLandudno, (except in the very short-term), without selling that first property?

Expect to see some disputes on this exception!

The second of the four exceptions, is that you will be regarded as being ordinarily resident in a residence for up to two years, if that residence was being erected on land acquired for the purpose of occupying that residence as a primary residence.

In this regard there seems to be some consternation that the ‘only one primary residence rule’ is not overridden by this exception. In our view this rule also affords you to have two primary residences at once i.e. the one you are in and the one being built.

Apart from what we have stated immediately above, there seems to be little explaining to do. Quite simply, you will be regarded as being ordinarily resident for a period of up to two years where land has been purchased with the object of erecting a primary residence thereon.

Nevertheless, despite the exception’s relative simplicity, there are a number of interpretational difficulties-

    When does the period of deemed ordinary residence begin? Is it when the land is purchased? When plans are drawn up? When the erection physically begins?

    What happens if you fully intend to occupy the residence as a primary residence, but change your mind on the matter?

The third of the four exceptions that allows for continuity of the period of ordinary residence for up to two years, is if the residence was accidentally rendered uninhabitable.

Again we see no reason why two residences should not be regarded as primary residences in terms of this rule. For example, if your home is badly fire-damaged, it would be quite a reasonable proposition to acquire a new primary residence and fix up the old one when the insurance pays out. The fire-damaged residence could then be disposed of and none of that time when you occupied the new residence as the primary residence should disturb the period of deemed continuous occupation of the old primary residence.

Having said that though there is a certain technical difficulty with this!

The fourth and final exception that allows for continuity of the period of ordinary residence for up to two years, is if the person with the interest in the residence dies.

Upon death there is a disposal of all assets previously owned by the deceased. However, the wording of the provision does not appear to cater for the intended relief as interpreted by SARS, (set out below). Nevertheless the interpretation is useful!

In terms of SARS’ draft Comprehensive Guide to Capital Gains Tax, on page 159, we quote -

    ...a primary residence held by the deceased estate is treated as being ordinarily resided in by the deceased person for a maximum period of two years after the date of death. Should the executor take longer than two years to dispose of the residence, the period exceeding two years will not qualify as a primary residence, and the gain or loss must be apportioned. The R1million exclusion may only be set off against the portion of the gain applicable to the first two years following the date of death.” (the emphasis is our emphasis).

It is the intention to allow the estate to be taxed at the same rate as the deceased for CGT purposes, and to enjoy the same inclusion rate and exclusions as would have applied to the deceased, (per page 159 of the SARS Guide).

Nowhere does the legislation lend itself to this form of interpretation, and while it should be advantageous to adopt it, we see some problems in giving effect to it.

Let’s look at an example-

D dies in September 2010. He acquired his primary residence in October 2001 for R1million. He resided in the residence as his primary residence throughout the period. At the date of death the property was worth R1.5million. This property was not bequeathed to anyone and was realised by the executor for R1.8million, three years after the date of death.

The legislation as it stands is not, in our view, capable of the interpretation set out in the above italics, however, we have little else to go on other than what is set out in the italics.

Thre seems to be two ways of interpreting this -

  1. Calculate the gain applicable to the deceased as at the date of death. Thereafter calculate the gain applicable to the deceased estate.
  2. Calculate the gain applicable to the deceased as if he lived in the house until 2012, (two years after the date of death).  

The approach in 2 above does not make any sense! The executor will be required to submit a tax return for the deceased the tax year ending February 2011. He may well get an extension for the submission of that return, but he will nevertheless not be in a position to determine the capital gain on the basis set out under 2, because neither the date of disposal, nor the proceeds will be known at that time. Furthermore, the general rule that the deceased is treated as having disposed of his assets on the date of death appears to counter this interpretation, (however, this is probably not the case as two year concession is a specific provision that could override the general rule).

If calculated on this basis the period of ordinary resdence would be 12 years, (nine while alive and three years thereafter in the hereafter). The period that D was not ordinary resident would be one year. (It took the executor three years to dispose of the residence of which two qualify as ‘ordinary resident’.) The capital gain is R800 000, of which 11/12th’s qualifies for exclusion. Therefore R66 666 is taxable in the hands of the estate.

Alternatively, if the interpretation under 1 is ‘correct’, (we believe that this is the more logical approach to the issue) -

First calculate the gain in the hands of the deceased for the tax year ending in the year of death. The market value, (proceeds), at that time was R1.5million and the base cost was R1million. There as is a gain of R500 000 and as the residence fully qualified as a primary residence over the entire relevant period, the entire gain, (being less than R1million), will be excluded from CGT.

As at the date of disposal by the executor the property was worth R1.8million. As at the date of death the property was worth R1.5million. It seems reasonable to assume that the property appreciated in value evenly over the three-year period. As such, the property could be said to have been worth R1.7million at the end of the two-year qualifying period.

In terms of SARS’ interpretation quoted above, “the R1million exclusion may only be set off against the portion of the gain applicable to the first two years following the date of death”. That portion of the gain is R200 000, (R1.7million less R1.5million). As that amount is lower than the R1million maximum exclusion, the full R200 000 will fall outside the CGT net.

The R100 000 gain attributable to the third year of the post-death holding period will be taxable in the hands of the estate.

We have dealt with the period apportionment exceptions on this page, the other apportionment exception/concessions are-

- the usage apportionment concession

- the land concession.