IN MY previous article I discussed the potential benefits of holding one’s primary residence in trust. It is, however, important to consider the following factors before placing your primary residence and other properties in a trust:
⦁ One would typically only transfer property into a trust if you are planning on keeping it for the long term. Transfer duty on the transfer into a trust has to be taken into consideration, and possible capital gains tax when you transfer it.
⦁ The trust will be the legal owner of the property, and the trustees will be responsible for its administration. This is often something estate owners cannot get their minds around.
⦁ If you are planning to sell the property at less than its market value (not at an arm’s length price), for the purpose of saving on capital gains tax, but you are a ‘connected person’ in relation to the trust (a beneficiary of that trust or a ‘connected person’ in relation to such beneficiary), the sale will be deemed to have taken place at its market value. The trust will then also be deemed to have acquired the property at its market value (paragraph 38 of the Eighth Schedule to the Income Tax Act). In addition, donations tax may be payable on the difference between the market value and the sales price of the property if, in the opinion of the commissioner, the consideration is inadequate. Such difference will be labelled a deemed donation (Section 58 of the Income Tax Act). Note that the commissioner’s discretion under this section is not subject to objection and appeal.
⦁ There are also tax consequences for selling income-generating properties to a trust on an interest-free or soft loan account at less than market value. If the property was disposed of by the South African resident individual to the trust for less than its market value, the difference between the selling price and the market value will be deemed a donation for the application of Section 7 (Section 7(9) of the Income Tax Act). This means that this difference is not necessarily subject to donations tax (because Section 7 does not deal with donations tax). However, as far as the resultant income is concerned, the transaction would fall into the provisions of Section 7 in terms of the difference between the selling price and the market value of the asset. Income on the difference between the sale price and the market value will therefore be taxed in the seller’s personal capacity.
⦁ When a bank loans money to a trust and the trust has little, if any, assets with the exception of the property, then you will either have to sign as surety or provide other security. Upon your death, the bank may put in a claim, and if the estate does not have sufficient equity, the bank has the power to sell the property to settle the outstanding bond. The larger the outstanding debt, the greater the risk that the trust will not protect this asset against a creditor, in this case, the bank. Other assets that may form part of the trust may be at risk of exposure too.
⦁ When finance is required to purchase a property, banks may demand a bigger deposit when a trust acquires a property, compared to individuals. This is due to the perceived risks associated with trusts, along with cases where the banks have had negative experiences with trusts.
⦁ In the case of a primary residence, the possibility exists that higher capital gains tax will be payable on the disposal of your residence by a trust. This is due to the loss of the primary residence exclusion (R2 million) for capital gains tax purposes on a primary residence held by a trust compared to an individual.
⦁ The sale of properties in a trust, and if the gain is not distributed to beneficiaries utilising the Conduit Principle, also attracts a higher capital gains tax rate (36 percent for the 2023 tax year) versus individuals (up to 18 percent for the 2023 tax year). This is also true for income generated in the trust on properties. However, remember the order in which tax on trust income or capital gains is paid and that the trust is always the taxpayer of last resort. Ensure that the trust instrument specifically empowers the trustees to distribute a capital gain to beneficiaries to enable trustees to make use of the lower capital gains tax rate in the hands of the beneficiaries by utilising the Conduit Principle. However, be mindful of the fact that should you distribute a capital gain to a beneficiary to pay less capital gains tax, you will increase the estate of the beneficiary for Estate Duty purposes and possibly defeat the object of creating a trust in the first case.
Estate planners have to carefully consider these factors before placing their primary residence in a trust to avoid unintended consequences.
Phia van der Spuy is a chartered accountant with a Master’s degree in tax and a registered Fiduciary Practitioner of South Africa®, a Master Tax Practitioner (SA)™, a Trust and Estate Practitioner (TEP) and the founder of Trusteeze®, the provider of a digital trust solution.
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