Tax implications of selling at a loss?

Posted On Monday, 25 August 2008 02:00 Published by
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With the property market in a down phase at the moment, it’s certainly not the ideal time to sell. However, if you are forced to sell you may be faced with a loss. Tax Partner at Cameron & Prentice Chartered Accountants, David Warneke, looks at the tax implications of losses on property transactions

If the taxpayer bought the property for speculation, the loss may be allowed as a deduction for normal income tax and CGT would not enter the equation. This would obviously be of benefit for the taxpayer, who would be able to set this loss off against other taxable income for the year. However, the taxpayer would have to jump through a number of hoops before the loss would be allowed on revenue account. These are that the taxpayer would have to prove that the property was indeed bought for speculative purposes and not as a capital asset or with mixed intentions (unless a change of intention to revenue took place prior to sale – see below), and that the purchase and sale of the asset was part of a ‘trade’ carried on by the taxpayer.

The SARS is understandably cagey when assessing a loss on the sale of a property. The temptation is of course for taxpayers to claim that the purchase of a property is for capital reasons when the market looks rosy, but when it turns sour, to claim that it had been for speculation. The question as to the capital or revenue nature of property acquired was previously asked on an individual’s income tax return, in the year of acquisition. Taxpayers were generally content to answer that the property had been purchased as a capital asset and this may come back to bite them! I note that this question is not asked on the new (2008) income tax return.

Where the property was purchased as a capital asset, generally the loss will be on capital account. However, courts have found that a change of intention prior to sale is possible. This is very difficult for the taxpayer to prove though, in that something beyond the mere decision to sell the property is required. For example, substantial development and marketing of the property would indicate a revenue intention.

In the event that the loss is on capital account, the following points should be noted. Firstly, the loss may not be set off against revenue income or gains, but may only be set off against capital gains.

Say the loss is R 500 000 and the taxpayer has (other) capital gains of R 600 000. The R 500 000 is set off against the R 600 000, leaving a net gain of R 100 000. This is reduced by the individual’s annual exclusion of R 16 000. The result, R 84 000, is multiplied by the individual’s inclusion rate of 25 % and the amount of R 21 000 is included together with the taxpayer’s other taxable income. If there are no capital gains in the same year, the loss is reduced by the annual exclusion of R 16 000 to R 484 000, which is carried forward to the following year, awaiting set-off against capital gains in that year.

It should be noted that, had the property been the individual’s ‘primary residence’, the loss of R 500 000 would have been reduced to R nil by the primary residence exclusion of R 1.5 million, which applies to losses as well as to gains!

Publisher: eProp
Source: Cameron & Prentice

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