FAQ: Tax & Accounting for Clients with Personal & Business Rental Income
Member Query
I have a client (a couple) who own multiple sectional title properties and earn rental income from them. These properties were originally purchased under their personal names, with the corresponding bonds also in their personal capacities.
Later, they registered a (Pty) Ltd and began receiving rental income into the business account while also covering the majority of property-related expenses through the business.
We seek clarity on the following:
Record-Keeping: What is the correct accounting treatment for transactions, given that the properties are owned personally but income and expenses are flowing through the business?
Tax Compliance: How should tax submissions be handled, considering the distinction between personal and business entities?
Best Practices Moving Forward: What is the most tax-efficient and legally compliant way to structure and manage this rental business in the future?
Our Response
Tax Implications
There are three options:
Selling the property
The individual owners can sell the properties to the company, with the company assuming responsibility for the bond payments. However, this transfer would trigger Capital Gains Tax (CGT) implications, as it involves a change in ownership from individuals to the company. Even though the individuals are shareholders in the company, legal entities and their shareholders are considered separate for tax purposes.
Leasing the property
Alternatively, the individual could lease out the properties to the company. So, note the following from:
The individual’s perspective:
The individual would earn lease income and deduct bond payments (as per section 11J, not section 11(a).
The Company’s perspective:
The company will earn an income (rental income) and incur expenses which are also tax deductible. The company must pay the lessor an amount for using the property.
Assets for share transaction
A natural person can transfer capital assets to a resident company in exchange for equity shares, provided the market value of the assets equals or exceeds their base cost (or, in the case of trading assets, their cost or closing stock value). This transaction can be carried out without triggering Capital Gains Tax (CGT) or normal tax on the gain.
Instead, with certain exceptions, the capital gain or gross income that would have accrued to the transferor (the individuals in this situation) is deferred and becomes taxable in the hands of the transferee company upon its future disposal of the asset.
This tax-deferral relief applies only if, at the end of the disposal day, the transferor—individuals, in this situation, —continues to hold a ‘qualifying interest’ in the transferee company (refer to section 42 of the Income Tax Act).
Alternatively, if the transferor is a natural person, they must be engaged full-time in the business of the transferee company.
Additionally, the transferee must classify the acquired capital asset as a capital asset and trading stock as trading stock.
A ‘qualifying interest’ includes:
Equity in a collective investment scheme: Any equity share held in an 'equity' collective investment scheme.
Minimum 10% ownership: Equity shares that constitute at least 10% of the equity shares and voting rights in the company.
Group company shares: An equity share held in a company that is part of the same group of companies as the transferor.
Disposals and acquisitions
When a transferor disposes of an asset to a transferee company in an asset-for-share transaction, the tax implications are as follows:
The transferor is deemed to have disposed of the asset at its base cost, avoiding CGT liability. They acquire the equity shares in the transferee company as if purchased on the original asset’s acquisition date, at a cost equal to:
For capital assets: The allowable as per ‘para 20 base cost expenditure.’
For trading stock: The cost or the trading stock value.
To qualify for the rollover tax relief, the individuals must hold the shares for at least 18 months.
Accounting entries - for illustration purposes only
Option 1. Selling the property to the company
This assumes the company purchases the properties from the individuals.
1. Recognition of Property in the Company's Books
When the company acquires the property, it records it at the purchase price. Assume the purchase price is R1,500,000 and no bond liability is taken over.
Journal entry for acquisition:
Dr Property, Plant & Equipment (Investment Property) R1,500,000
Cr Share Capital R1,500,000
(Recognition of the property transfer to the company in exchange for equity shares)
2. Derecognition in the Individual’s Books
Dr Investment in (Pty) Ltd R1,500,000
Cr Property Disposal R1,500,000
(Derecognition of the property exchanged for shares in the company)
3. Capital Gains Tax (CGT) Liability
CGT is calculated based on the gain (Sale Price - Base Cost). Assuming:
• Sale Price = R1,500,000
• Base Cost = R1,000,000
• Capital Gain = R500,000
• Effective CGT Rate = 36% for individuals
• CGT Liability = R180,000
Journal Entry (Individuals’ Books - CGT Recognition):
Dr Capital Gains Tax Expense R180,000
Cr SARS Payable (CGT) R180,000
(Recognition of CGT liability on the gain)
4. Rental Income Recognition in the Company’s Books
The company now receives rental income from the property:
Journal Entry (Company’s Books - Rental Income):
Dr Bank R20,000
Cr Rental Income R20,000
(Recognition of monthly rental income received by the company)
5. Rental Expenses Paid by Company
Journal Entry (Company’s Books – Property Expenses Paid):
Dr Expenses R3,000
Cr Bank R11,000
(Recognition of monthly property-related expenses paid by the company)
Option 2. Leasing the Property to the Company
The individuals retain ownership and lease the property to the company, which pays the owners a monthly rent of R20,000. There are no CGT or transfer costs as the property remains in the individuals' names.
The company gets a tax deduction for rental payments. The individuals pay personal tax on rental income at their marginal tax rate. The individuals are still responsible for all property-related expenses (bond, rates, levies, maintenance).
1. Recording rental expense in the company’s books
Dr Rental Expense R20,000
Cr Bank R20,000
(Rental payment to the individual owners)
2. Recording rental income in the individuals’ books
Dr Bank R20,000
Cr Rental Income R20,000
(Recognition of rental income received)
3. Expenses recorded in the individuals’ books
Dr Expenses R10,000
Cr Bank R10,000
(Recording expenses paid)
Option 3. Asset-for-Share Transaction (Section 42 Roll-Over Relief)
This transaction allows the individuals to transfer the property to the company in exchange for shares, deferring the capital gains tax.
1. Recognition of property in the company's books
Dr Property, Plant & Equipment (Investment Property) R1,500,000
Cr Share Capital R1,500,000
(Recognition of property in exchange for shares)
2. Removal of property from individuals’ books
Dr Investment in (Pty) Ltd R1,500,000
Cr Property Disposal R1,500,000
(Removal of property in exchange for shares)
3. No immediate CGT liability, only deferred tax
Under Section 42, there is no immediate CGT if the individuals hold shares for at least 18 months. However, a deferred tax liability is recognised:
Dr Deferred Tax Asset/Liability R180,000
Cr Deferred Tax Income R180,000
(Recognition of deferred tax effect on gain deferral)
4. Rental income in the company’s books
Dr Bank R20,000
Cr Rental Income R20,000
(Recognition of rental income)
5. Expenses paid
Dr Expenses paid R10,000
Cr Bank R10,000
(Recording expenses paid)
Which option is the best for tax efficiency and compliance?
The best approach depends on the client’s long-term goals.
For tax deferral and business structuring, the Asset-for-Share transaction (Option 3) is the most beneficial.
For simplicity and avoiding CGT liability, leasing the property to the company (Option 2) is a better choice.
For full business integration, selling the property to the company (Option 1) is viable but comes with higher immediate tax costs.
What are the key compliance risks to avoid?
Incorrect tax filings: If the company reports rental income from personally owned properties as its own, this can lead to incorrect tax treatment and penalties.
CGT miscalculations: Selling a property to a company without considering CGT can lead to unexpected tax liabilities.
Improper deductions: Claiming deductions incorrectly (e.g., bond interest deductions in the company when the loan is in the individuals’ names) may trigger SARS audits.
Final Advice
Proper structuring from the start is crucial to avoid unnecessary tax liabilities and compliance issues.
If considering a business restructure, consult a tax specialist to assess the impact of CGT, VAT, and other potential costs.
SARS guidelines must be strictly followed to avoid tax penalties and ensure accurate reporting.
