I have had quite a number of enquiries from clients asking whether they should take advantage of the newest tax concessions and transfer their primary residence held in a trust, tax free, into their personal names.

In answering this question we will first look at the requirements of the concession and then consider whether it is worthwhile making use of.

The requirements

Paragraph 51 of the 8th Schedule to the Income Tax Act, provides that a natural person may acquire a residence from a trust (or a company/close corporation) without having to pay transfer duty, capital gains tax or dividend tax, if the following requirements are met:
  1. the natural person acquires the residence from the trust before the 1st of January 2012; and
  2. the natural person alone or together with his/her spouse have directly held all the share capital or members’ interest in the company/close corporation from 11 February 2009 to the date of registration of the residence in the deeds registry
    or
    where he/she disposed of the residence to that Trust by way of donation, settlement or other disposition or financed all the expenditure included its base cost actually incurred by the Trust to acquire and to improve the residence; and
  3. the natural person alone or together with his/her spouse must personally and ordinarily have resided in the residence and used it mainly for domestic purposes from 11 February 2009 to the date of registration; and
  4. in respect of so much of that land that does not exceed 2 hectares.
It should be noted that ALL these requirements need to be met in order to qualify for the concession.

The above requirements will be applicable for transfers done until 30 September 2010. Paragraph 51A will be inserted in the Act shortly. For transfers between 1 October 2010 to 31 December 2012, the following additional requirements must be met: the corporation/company/trust must be wound up within 18 months after the property was transfered; the primary residence must comprise 90% of the value of the assets of the corporation/company/trust for the entire period this asset was held.

If you qualify for the exemption, you can now consider whether it would be worthwhile to transfer it into your personal name.

Is it worthwhile?

To answer this question you should revisit the reasons the residence has been put in the trust in the first place, for example:
  1. to protect it against personal creditors;
  2. to save costs of winding up of your estate;
  3. preservation after death;
  4. to save estate duty;
  5. to protect it from spendthrift children or a vulnerable spouse;
  6. to protect your minor children or vulnerable children, especially if a child is retarded in some manner;
  7. to ensure confidentiality (trust documents are not in the public eye);
  8. to ensure access to income and capital after your death.
If your reasons for having it in a trust in the first place are still valid, it should remain in the trust.

Is it worthwhile? – Capital Gains Tax.

One consideration is the capital gains tax effect on the sale of the residence. 50% of the gain will be taxed at the trust’s tax rate, namely 40%. The effective rate on the gain is therefore 20%. The maximum rate on a capital gain for a natural person is 10%, as the inclusion rate is 25% and the maximum tax rate is 40%. Another consideration is the R1,5m primary residence exclusion which is available to natural persons.

This is best illustrated with an example:

TrustNatural
person
Proceeds on saleR 4 000 000R 4 000 000
Less: Base costR 2 000 000R 2 000 000
Capital gainR 2 000 000R 2 000 000
Less: Primary residence exclusionR 1 500 000
R 2 000 000R 500 000
Less: Annual exclusionR 17 500
GainR 2 000 000R 482 500
Inclusion rate50%25%
Taxable gainR 1 000 000R 120 625
Maximum tax rate40%40%
Tax on gainR 400 000R 48 250


If the disposal proceeds of a primary residence owned by a natural person does not exceed R2m, capital gains tax is not applicable and no capital gains tax will be paid.

The effect of the high capital gains tax in the trust can be softened if the capital gain is distributed to beneficiaries. If the trust above had four beneficiaries and the R2m gain was distributed to them equally, the tax position would be as follows:

No tax would be paid by the trust as the full gain is distributed.

The recipients of the gain will be taxed as follows:
For each beneficiary:

Capital gainR 500 000
Less: Annual exclusionR 17 500
R 482 500
Inclusion rate25%
Taxable gainR 120 625
Maximum Tax rate40%
Tax on gain (for 1 beneficiary)R 48 250
Tax on gain (for 4 beneficiaries)R 193 000

The R193 000 tax is much less than the R400 000 the trust would have paid were there no distributions, but it is still considerably more than the R48 250 the natural person pays taking into account the R1,5m primary residence exclusion.

From a capital gains tax point of view, the natural person option seems to be best.

Is it worthwhile? – Estate duty

The effect of estate duty may nullify the above conclusion. It is a certainty that the property will increase in value over time. Let us assume the property was transferred from you to the trust at R4m on loan account. The trust never repaid the loan hence that loan forms part of your estate. The property increased in value and its market value is R10m at the time of your death. The following calculations show the estate duty effect of the property being part of your estate or being part of the trust.

When part of your estate:

Value of property at time of deathR 10 000 000
Less: Section 4A deductionR 3 500 000
Dutiable amountR 6 500 000
Estate duty at 20%R 1 300 000


When part of the trust:

Value of loan account at time of deathR 4 000 000
Less: Section 4A deductionR 3 500 000
Dutiable amountR 500 000
Estate duty at 20%R 100 000


The estate duty saving is an enormous R1 200 000 in this example!

The rule of thumb is that you will save 20% of the result of the difference between the market value of the asset at time of death and the value of the loan account, ie:

Market value at time of deathR 10 000 000
Less: Loan account at time of deathR 4 000 000
ResultR 6 000 000
Estate duty at 20%R 1 200 000


The above example also illustrates the point that the growth of the asset (R6m) was ‘pegged’ at R4m by having the asset owned by the trust.

From an estate duty point of view, the asset should clearly remain in the trust.

CONCLUSION

Generally, it would almost always be a good idea to keep the property in the trust, but as there are many factors to consider, there is no easy ‘yes’ or ‘no’ to this question. Each case will have to be judged by its own merits.

If you consider transferring your assets from your trust into your own name, don’t rush. To make use of the current tax concessions, there is until 31 December 2011 to do so. This will afford you the opportunity to contact an expert and consider all the different scenarios before you take action.

Kindly contact us should you need to discuss any matter with us.