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Capital Gains Tax and the Primary Residence Exclusion

Prepared by CORE TAX | Gary McLean, CA(SA) Member | CHARTERIS & BARNES | www.cbarnes.co.za 

A taxpayer selling his home could qualify for the primary residence exclusion of up to R2 million for Capital Gains Tax (CGT) purposes. The term “primary residence” is defined in paragraph 44 of the Eighth Schedule to the Income Tax Act.
The reason this definition has captured the minds of many is due to the exclusion on the gain or loss made on the disposal of one’s primary residence.
There are two possibilities:
If the primary residence is sold for more than R2 million, the first R2 million of the capital gain or loss should be disregarded.
If the primary residence is sold for R2 million or less and a capital gain is realised, the full capital gain is disregarded.
To qualify as a primary residence, and receive the benefit of the exemption, a residence must be one in which a natural person or a special trust holds an interest. In addition, the natural person or a beneficiary of the special trust or spouse of the person or beneficiary must ordinarily reside or have resided in the residence as his or her main residence; and use or have used the residence mainly (more than 50%) for domestic purposes. In order for the property to qualify as a primary residence, the residence must meet both of the latter requirements or face disqualification as a primary residence. The definition also makes it clear that a company, ordinary trust or close corporation owning a residence will not qualify for the primary residence exclusion. The R2 million gain exclusion operates on a “per primary residence” basis and not on a “per person holding an interest in the primary residence” basis. This means that where, for example, two individuals have an equal interest in the same primary residence and both of them use it as a primary residence, the R2 million must be apportioned and each will be entitled to a primary residence exclusion of a maximum of 50% of R2 000 000, i.e. R1 000 000. This would typically apply to spouses married in community of property where each spouse is deemed to hold a 50% interest in the residence.
In order to determine the portion of the capital gain or loss that qualifies for the primary residence exclusion, the following requirements need to be considered:
The exclusion is limited to a land size of two hectares (on condition that the two hectares are utilised as a part of the primary residence)
The exclusion is limited to the period occupied as a primary residence
The exclusion is limited to the residential use of the primary residence
The capital gain or loss needs to be apportioned regarding each of these three limitations in order to determine the portion of the capital gain or loss that qualifies for the primary residence exclusion.
When a person disposes of a primary residence, the exclusion of the capital gain or loss will apply only to the period that the person was ordinarily resident in the primary residence.

This means that a person need not be living in the residence at the time of the sale in order to qualify for the primary residence exclusion. The person only had to use it as a primary residence for a part of the time he or she owned it. The capital gain or loss to be disregarded in these circumstances must be determined with reference to the period during which the person concerned was ordinarily resident in the residence. Certain periods of absence from the primary residence are deemed as still being periods of primary residence, for example, the residence was offered for sale while it was his primary residence and he vacated it due to the acquisition, or intended acquisition, of a new primary residence; the residence was erected on land acquired for the purposes of building his primary residence; the residence was accidentally rendered uninhabitable, or the taxpayer died.
Where the period of absence exceeds two years, the natural person or the beneficiary of a special trust is treated as still being ordinarily resident in the residence, but only for two years out of the total period of absence. When a person disposes of a primary residence, the exclusion of the capital gain or loss will apply only to the residential use of the property. Any trade or non-residential use of the primary residence does not qualify for the exclusion. The capital gain or loss should be adjusted with both the period of trade use and the part of the residence that is used for trade.
Certain periods of letting, where the person is absent from the primary residence for five years or less, will still be treated as periods of residential use. This concession applies if the person (or spouse or beneficiary of a special trust) concerned resided in the residence as a primary residence for a continuous period of at least one year prior to and after the period of letting, and no other residence was treated as his or her primary residence during the period of letting, and he or she was either temporarily absent from South Africa during the period of letting or was employed or engaged in carrying on business in South Africa at a location further than 250 kilometres from the residence during the relevant period. Where the period of absence exceeds five years, the natural person or the beneficiary of a special trust is treated as having used the residence for trade purposes (i.e. not domestic purposes) for the entire period of absence.
It is important to note that it is the capital gain which is apportioned and not the R2 million exclusion. Capital gain = proceeds (exceeding R2 million*) less base cost less the portion of the gain that relates to land that is greater than two hectares less the portion of the gain that relates to the period the property was not occupied as primary residence less the portion of the gain that relates to the trade use of the primary residence equals the portion of the capital gain which qualifies for the primary residency exclusion of R2 million.
The portion of the gain that relates to land that is greater than two hectares plus the portion of the gain that relates to the period the property was not occupied as primary residence plus the portion of the gain that relates to the trade use of the primary residence equals the portion of the capital gain that does not qualify for the R2 million gain exclusion and will be subject to CGT in full.
Although a primary residence is used mainly for purposes other than the carrying on of a trade, the fixed property is excluded from personal-use assets. The only exclusions from CGT for a capital gain or loss made on a primary residence are the exclusion.