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How home office deduction impacts Capital Gains Tax

With “flexible” employment being the new buzzword, more and more people are working part or all of the week from an office in their home. Eliminating the daily commute, saves staff valuable time in their day which they can put to good use from the comfort of their own house.

Home office expenses qualify as a tax deduction if various conditions are met. This means they reduce taxable income and ultimately your tax liability. However, not just anyone qualifies to deduct his or her home office expenses. Check out our decision tree here to see if you qualify for this deduction. You can also read our blog to find out what you can deduct and how to calculate this deduction.

While people are eager to claim the home office tax deduction in order to reduce their taxable income (and ultimate tax liability), few people understand the negative tax impact a home office has on the calculation of their capital gains tax, when they sell their property one day in the future.

Let’s first look at the tax rules around the sale of your home which you use exclusively as your primary residence. As you may already know, there is a primary residence exclusion of R2m which means the first R2m of the capital gain (or loss) is excluded for the purposes of working out the Capital Gains Tax. All individual taxpayers receive an additional R40 000 capital gains exclusion per year. The following example illustrates how the primary residence exclusion works.

Isabel purchased a home in February 2005 for R1 200 000. In February 2013, she carried out renovations to add on an extra bedroom and spent R300 000. She lived in this home until February 2017 when she sold it for R3 500 000. Her taxable income for 2017 was R500 000.

The Capital Gains Tax calculation is as follows:

Proceeds: R3 500 000

Base Cost: R1 200 000 + R300 000 = R1 500 000

Capital Gain (proceeds – less base cost): R3 500 000 – R1 500 000 = R2 000 000

Less: primary residence exclusion: R2 000 000 – R2 000 000 = nil

The annual exclusion of R40 000 is not relevant here because the Capital Gain is nil so cannot be reduced further.

Therefore, the sale of Isabel’s home has no impact on her capital gains tax liability. This is because the capital gain (R2m) is equal to the primary residence exclusion (R2m) which reduces it to nil.

You can also use TaxTim’s handy CGT calculator to do the hard work for you.

Now let’s use the same example and assume all details remain the same, but instead of an extra room, Isabel carried out renovations for R300 000 to add on an office from where she worked until she sold her home in February 2017. The office space made up approximately 10% of her total house space (i.e it was 10 square meters, while her entire home was 100 square meters) and she therefore claimed 10% of her house running costs as a tax deduction against her business income.

In this situation, the Tax Act requires the capital gain to be apportioned between primary residence use and business use. This apportionment must take into account two factors:

- The length of time that the home office was used as a portion of the entire period of ownership (4 years out of 12 years in our example)
- size of the home office compared to the size of the entire property (10% in our example)

Assuming all other details are exactly the same as in the first example , the Capital Gains Calculation is as follows:

Proceeds: R3 500 000

Base Cost: R1 200 000 + R300 000 = R1 500 000

Capital Gain (proceeds – less base cost): R3 500 000 – R1 500 000 = R2 000 000

Less: apportionment for period (4 years) during which home was partially used (10%) for home office purposes:

R2 000 000 X 4/12 X 10% = R66 666

Portion of the capital gain attributable to the property’s use as a primary residence:

R2 000 000 – R66 666 = R1 933 334

Less primary residence exclusion: R1 933 334– R2 000 000 = nil.

Portion of the capital gain attributable to the property’s use as a home office:

R2 000 000 – R1 933 333 = R66 666

Total Capital Gain: R66 666

Less: annual capital gain exclusion R66 666 – R40 000 = R26 666

The inclusion rate for capital gains is 40% for individuals. This means that 40% of the gain (i.e. R26 666 X 40% = R10 666) is added to Isabel’s taxable income and will be taxed at her marginal rate of tax.

If we assume her marginal tax rate is 36%, then approximately R3 840 capital gains tax will be payable (i.e. R10 666 X 36%).

Just to remind you, if she had not used part as a home office, then the capital gains tax on the disposal of the property would have been nil as illustrated in the first part of the example.

Isabel would need to compare this capital gains tax (R3 840) with her annual tax saving as a result of claiming a home office deduction to decide which is more advantageous from a tax perspective. It seems likely that it would be worth it for Isabel to claim home office expenditure annually and the tax benefits would outweigh the capital gains tax she would need to pay on disposal.

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