Claude McKirby, Co-Principal for Lew Geffen Sotheby’s International realty in Cape Town’s Southern Suburbs and False Bay explains: “Capital gains tax is a tax levied on the profit made from selling an asset, such as property. In other words, when you sell a property for more than you paid for it, the difference (your capital gain) is subject to CGT.
“The capital gain is calculated as the difference between the selling price and the base cost, which includes the purchase price and any allowable expenses like improvements.
“For primary residences, the first R2 million of the capital gain is exempt from CGT and this concession is known as the primary residence exclusion. For secondary properties, no such exemption exists, making it even more critical to understand how to reduce your taxable gain.”
He adds that the concession is only applicable if the primary property is registered in a natural person’s name. If the property is in a company or trust, the R2m concession does not apply.
One of the most effective ways to reduce your CGT bill is by offsetting the cost of home improvements, however, McKirby cautions that it's essential to distinguish between what constitutes an "improvement" and a "repair," as only improvements can be used to reduce your capital gains.
“Understanding the distinction between home improvements and repairs is key to effectively managing your tax liability as this difference determines whether you can add the expense to the base cost of your property, thereby reducing your capital gain and, ultimately, the tax payable,” says McKirby.
Home Improvements:
“Home improvements refer to changes or additions to your property that increase its value, extend its useful life or adapt it to new uses. These improvements are capital in nature and can be added to the base cost of your property for CGT purposes.
“Examples include adding an extra room or bathroom, installing a swimming pool, upgrading from basic to luxury finishes, such as marble countertops or hardwood flooring, building a garden wall and installing solar panels or energy-efficient windows.
“These types of expenditures are considered capital improvements because they enhance the property’s overall value and, therefore, can be used to offset your capital gains.”
Repairs:
“Repairs are expenditures incurred to maintain the property in its existing condition without enhancing its value. These costs are considered revenue in nature and are not deductible from your capital gain.
“Examples include replacing a broken window, fixing a leaky roof, repainting tired walls in the same colour and repairing plumbing or electrical issues.
“These expenses are generally aimed at restoring the property to its original state rather than improving it and, as such, cannot be used to reduce your capital gains tax.”
To take full advantage of the tax benefits associated from home improvements, it is crucial to maintain detailed and accurate records. McKirby offers the following tips:
- Keep All Receipts and Invoices: Store receipts and invoices for all improvement-related expenses. Make sure they clearly indicate the nature of the work done, as this will be essential in proving that these costs are capital improvements rather than repairs.
- Document the Changes: Take photographs of the property before and after the improvements. This visual evidence can be helpful in demonstrating how the improvements have increased the property's value.
- Maintain Contracts and Plans: Keep copies of any contracts with builders, architects, or contractors, as well as any plans or permits related to the improvements. These documents can help substantiate your claim that the expenses were for improvements rather than repairs.
- Record Dates: Note the dates when the improvements were made. This can be important in the event of an audit, as the timing of the improvements can also affect their classification.
“When you sell your property, you will need to calculate the capital gain by deducting the base cost (including allowable improvements) from the selling price.
Here's how to include your improvements:
1. Determine the Base Cost: Start with the original purchase price of the property.
2. Add the Cost of Improvements: Include the cost of all qualifying improvements made over the years.
3. Subtract Selling Costs: Deduct any expenses directly related to the sale of the property, such as agent fees, advertising costs, and legal fees.
4. Calculate the Capital Gain: Subtract the adjusted base cost (purchase price + improvements + selling costs) from the selling price. This amount is your capital gain.
5. Apply the Exemption: If the property is your primary residence, apply the R2 million exemption to the capital gain. The remaining amount is subject to CGT.
“Understanding the difference between home improvements and repairs is vital for homeowners looking to minimise their capital gains tax liability when selling a property and by carefully tracking your improvement expenses and ensuring they qualify under the guidelines, you can significantly reduce the amount of tax payable.
“However, it’s advisable to consult with a tax professional to ensure you are correctly applying these principles to your specific situation, as tax laws can be complex and subject to change,” concludes McKirby.