Property Investing in South Africa: Section 13 sex

Use sec 13 sex to increase your property ROI

Property investing in South Africa has long been a darling of investors. From discussions with friends or your hairdresser, everyone has an opinion about property. This article will not only provide details on one of SARS' best-kept secrets but will make for a good story around your next braai.

Long-term real growth (growth above inflation) for property in South Africa stands at 1.9%, meaning we aren't used to much capital growth. Sure there are pockets of value, and buying at the right price will always ensure good profits. When it comes to financial independence and property investing in South Africa, investing for monthly income should be your goal. You can invest for capital growth or have other streams of income, but at the end of the day, you will have to convert this active income into passive, income-generating properties. 

Section 13 Sex is a little secret SARS has for property investors in South Africa that can assist with your cash flow. Efficient use of this incentive can make your portfolio cash flow positive, while not paying a cent to SARS.   

What is section 13 sex?

Section 13 sex is a section of the income tax act that replaced the old section 13 ter. It covers a tax incentive for property investors and developers through incentives to invest and stay invested for the long term. The section 13 sex incentive allows qualifying investors to claim back up to 55% of the cost price of a property over 20 years from SARS. In this article, we will be focusing on the investors' point of view and look at how this act could be of benefit to the investors. 

Criteria for the section 13 sex deduction 

To qualify for this deduction, the below criteria will have to be met to submit your deduction to SARS. SARS will enquire proof of all the purchases and necessary documentation. Let's dive into the criteria:

• The taxpayer must own 5 residential units, and all the units must be within South Africa. It does not have to be at the same time, but deductions can only be made after the 5th unit is purchased. This criterion makes for a costly investment, and it's not recommended to chase after this deduction if you are building your property portfolio slowly and over a long time. 
• The units must be new and unused and be solely used for trade (residential letting). Meaning the owner is buying a new unit and placing a tenant. You can't live in a unit and claim the deduction. 

A 5% annual deduction is allowed for these residential units and a further 5% is allowed for low-cost housing (apartments up to R350 000). In this article, we will cover non-low-cost housing examples. 

The downside to Section 13 sex 

As Frugal Local indicated in this article, you might cry when you see the downsides to section 13 sex. As section 13 Sex deduction incentives to stay invested for the long run, there are clawbacks involved when a property is sold. Meaning you will have to repay all the tax breaks you received if a unit is sold, or if the unit is sold in the event of death. This clawback also applies when transferring a unit from one entity to another even though you own both entities, as the unit loses the new and unused status. These clawbacks only apply during the first 20 year period, after this no clawback applies when selling, death or moving to another entity occurs. Ensuring you invest in the correct tax structure will ensure efficient tax planning, and prevention of these clawbacks in the event of death during the first 20 years.  

Examples of Section 13 sex

Investor X buys 5 residential units at a price of R900 000 each. Total costs (includes all incurred costs) = R4,5m. The law states that 55% of this cost can be deducted at 5% per year for 20 years. So we take R4.5m multiplied by 55% equals R2,475m. At 5%, this is an R123 750 deduction each year.

Effects of marginal tax rate: A tax deduction is only as powerful as your marginal tax rate. Personal income tax can go as high as 45% depending on your sliding scale, companies are at 27% and trusts are taxed at 45%. 

To continue the example, let's say all your units are bought in a company, then the tax break that you will receive will equal R123 750 x 27% (company tax rate) = R33 412.5 per annum or R2 784,38 per month. Depending on your tax structure, you can change your marginal tax rate in the formula. These tax breaks can make a dramatic impact on your monthly cash flow and returns. Remember that SARS is not giving you money back, you are just paying less tax. 

How the tax break increases your ROI: Let's make a calculated guess that the investor is earning R7000pm per unit after all fees. This is a net return of R7000 x 5 (units) = R35 000 multiplied by 12 for the year's income equals R420 000. R420 000 divided by your initial cost of R4,5m equals 9.3%. Taking into account your tax break, R420 000 plus R33 412.5 (tax break) the return increases to 10.07%

Summary: 

Due to the high cost involved with buying 5 units, just for a tax deduction might not be a wise decision as you can only start claiming the deduction after the 5th unit. If you are a long-term property investor and have the means to purchase or fund 5 properties at once then this deduction might be for you. Ensuring you invest in the correct tax structure is vital as your marginal tax rate affects the amount you receive back from SARS.

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