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Rent To Buy CGT
- 13 August 2024
- Accounting
- The Tax Faculty Tax Specialist
This article is based on tax law for the year ending 28 February 2025.
1. Factual Background
In a rent-to-buy agreement, the sale price when the option to purchase a property is exercised is typically lower than the market value. The monthly payments made by the tenant are considered contributions towards the property's purchase, reducing the overall amount owed at the time of sale.
2. The Problem
What are the tax implications for the lessor when the option to buy is exercised?
3. Applicable Law
ITA 58 of 1962 Eighth Schedule, paragraph 13, 20
4. Application of the Law to the Facts
A rent-to-buy agreement is a process in which a buyer commits to renting a property for a specified period of time, with the option of buying the property. The seller and the potential buyer sign a rental agreement for a specified term, at the end of which, the tenant will be able to choose whether or not to purchase the property. The tenant and the landlord must sign a lease agreement that stipulates all the terms and specific conditions of the agreement including the lease duration, deposit and monthly rental payment. The monthly rental payments received by the lessor from the lessee are generally treated as income and should be declared as "rental income" in the annual ITR12 tax return.
The selling price of the property is determined and fixed at the beginning of the lease agreement, therefore the seller cannot inflate the agreed-upon figure should property market values change. In some cases, the parties may agree that the prospective buyer's total rental costs during the lease period will be subtracted from the purchase price should they go ahead with the purchase at the end of the lease.
When the lessee exercises the option to purchase the property, capital gains tax is triggered for the seller. The capital gain is calculated by subtracting the base cost of the property from the sale price. The base cost includes the original purchase price of the property plus any allowable expenses incurred in acquiring and improving the property, as stated in Paragraph 20.
The Offer to Purchase agreement between the seller and purchaser should stipulate the selling price of the property. The capital gain is realised at the time the sale is effected, which is when the lessee exercises their option to purchase. According to Paragraph 13, this occurs when a binding sale agreement is entered into, transferring ownership or substantially all the risks and rewards of ownership to the purchaser.