Most investors know that in South Africa, as opposed to other countries like the US, property investors cannot depreciate residential buildings. We all know that some changes have been made to allow depreciation on commercial buildings but residential buildings according to tax law doesn’t have many options. As you noticed, I said many options, there is though one option in the law that is somewhat constrictive, but which may still be a viable option for buy to let investors. That statement needs a minor correction, in this article we will be referring to a new term “develop-to-let”. Hang on a bit here and we will explain everything.

We found that there is an allowance in the tax law that enables property investors to depreciate a building and before we wrote this article we went out to investigate the information and give you some examples of how you can depreciate a residential building and in what conditions. So here goes…

Section 13ter of the Income Tax Act No. 58 of 62 provides for the only residential building allowance in the entire tax legislation.

To qualify for the allowance, the buildings must meet the definition of a housing project. This entails that the building is ERECTED by the taxpayer and that there are more than five residential units. Erected in our case means in simple words DEVELOPED, hence our terms in this article: “develop-to-let”.

Each residential unit must also be self-contained and consist of more than one room.

This means that they must be able to function independently and have a bathroom and kitchen. Hostels, hotels and similar accommodation are specifically excluded from being a residential unit and will therefore not qualify for this deduction.

The legislation states that any residential unit, the erection of which was commenced on or after 1 April 1982 and which was erected under a housing project for the purposes of:

• Being let to a tenant to derive a profit for the taxpayer.
• Being occupied by a full time bona fide employee of the taxpayer

In the above case the taxpayer will receive a two percent allowance (known as a residential building allowance), per year, on the cost of the residential units, as well as a ten percent initial allowance in the first year.

Take into consideration that the erection of the building is presumed to have commenced on the day the foundation is laid.

To go further and understand this, the initial allowance is received in the year in which five or more of the units are rented out or occupied for the first time, the subsequent allowance is claimed every year thereafter starting in the year in which the initial allowance was claimed.

So far so good, you can have an allowance in the residential sector to depreciate a development. Notice I said development not building, because it must be “erected” in other words “developed” by the investor. But of course, like everything else in life, terms and conditions apply and next is a quick checklist of requirements.

Checklist of requirements:

• The Taxpayer must have built the units
• Must be five or more units
• Each unit must be self contained
• The units must be let to a tenant or occupied by an employee of the taxpayer
• Five or more of the units must first be occupied before we can claim an initial allowance or any subsequent allowances.

If, in subsequent years any unit ceases to become available to let or to be occupied by an employee, (i.e.: you turn it into an office or sell) the taxpayer shall include in gross income a recoupment equal to:

The amount of initial allowance (the 10%) on the building less one tenth of the allowance for every completed year it was used as a residential unit.

• The allowance of 2% per year shall also not be deducted in that year or any future years in respect of that unit.

Lets see how this may work in an example:

Company “X” Erects a housing project consisting of seven units in March 2002 at a cost of 1.4 Million

At the year ended 31 December 2002 two units are let out and an employee occupies one.

Obviously they cannot claim any allowances in 2002 because less than five units have been occupied.

In June 2003, three more units become occupied.

For the year ended 31 December 2003, company “X” will be able to claim the following allowances:

• Initial allowance: 10% of 1.4 million. 140,000   
• Yearly allowance for the year 2003: 2% of 1.4 million. 28,000

In March 2007 Company “X” sells one unit.

Completed years:

• June 2003 - June 2006- 3 Years
• June 2006 - March 2007 is not a completed year.

The recoupment shall therefore be:

• The initial allowance in respect of that unit: 140,000/7= 20,000
• Less 10% for every completed year: 20,000/10*3= 6,000
• Recoupment: 14,000

Company “X” will also not be able to claim the 2% yearly allowance in the year ended 31 December 2007 and any future years in respect of that unit.

Now, that is all fine, but to get these deductions the act also says that you must include in your gross income all the moneys collected for rentals from these units.

So, in summary you can build 5 or more residential units and have deductions on these for as long as they fall under the requirements of this section in the act. This doesn’t prohibit you from selling but you will have to pay tax in the form of recoupments as described above, plus you won’t be able to further deduct in the future on that unit that is sold or re-purposed.

Here is the interesting part. In the first year you actually deduct the 10% + the 2% allowance which leaves you with the 88% of the value still to be deducted, which in essence means that if you wish to completely deduct this development you would need some 44 years.

This truly brings a new meaning to long holding in property investing. Maybe worth putting in a trust, since the holding may be very long and inherited by your children, after all 44 years is quite a long time.

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