A residential property market in limbo

The recent spate of interest rate increases and the fear of more increases to come have effectively brought the residential property market to a screeching halt. This article deals with the impact if residential properties are temporarily rented out in anticipation of future sales.

Introduction

Developers of residential property are facing challenges to move their stock in a depressed market caused by increased interest rates and other political and socio-economic uncertainties.

Many developers are now taking the route of renting out property in anticipation of future sales thereof. The VAT consequences of this course of action must be understood and considered carefully before a decision is made on the appropriate course of action.

The general rule

Where a VAT vendor acquires goods for taxable purposes and subsequently uses it for non-taxable purposes, the VAT vendor is deemed to have supplied the goods in the tax period in which the goods are used for other purposes and must account for output tax on the market value of the goods.

A property developer that develops residential property for sale and subsequently rents the property out, must account for output tax on the market value of the property in the tax period that the property is first rented out.

The fact that the input tax that the property developer could claim was much less than the output tax payable on the market value of the property is, as they say, too bad too sad.

But there is light in the tunnel …

The light in the tunnel

Developers of residential property that temporary rent out developed property in anticipation of the future sale thereof, only need to account for output tax on the adjusted cost of the property when it is first rented out.

The adjusted cost is the amount on which VAT has been paid and claimed by the developer in the process of developing the property. This essentially means that the developer only has to refund the input tax previously claimed from SARS to SARS.

But don’t forget the terms and conditions …

The terms and conditions

Yes, there are always terms and conditions.

The above rules only apply in respect of rental agreements for a period equal to or shorter than one year. If rental agreements are entered into for a period longer than a year, output tax will immediately become payable on the market value of the property.

At the end of the first year, the above rules will also no longer apply and if the property is still rented out, output tax will become payable on the market value of the property. The good news is that the vendor will be allowed a deduction of the output tax previously paid on the adjusted cost when the property was first rent it out.

If the property developer at any stage during the year decides to in future only rent out the property, output tax will also immediately become payable on the market value of the property and a similar adjustment as discussed above will be allowed.

Let’s look at planning opportunities  …

Planning opportunities

When a developer decides to temporarily rent out a property earmarked for ultimate resale, the initial agreement or agreements for the rental of the property should never exceed 12 months as this will trigger output tax on the market value of the property.

At the end of the first year of renting out the property, the property developer should consider whether it wishes to continue renting out the property.

If he discontinues renting out the property there will be no further output tax payable and the developer will be entitled to claim back the output tax previously paid to SARS when the property was initially rented out.

If the property developer decides to continue renting out the property, output tax will become payable on the market value of the property and the developer will be entitled to a deduction of the output tax previously paid when the property was first rented out.

Ultimately it is an issue of managing an organisation’s cash flows.

Planning, planning, planning …

Summary

As with most other things, appropriate knowledge is power. When renting out properties earmarked for resale by developers a deep understanding of the rules is essential to avoid costly mistakes.