Prime
Understanding tax aspects of real estate transactions
Mr Allan Atwiine
What you need to know:
"...real estate taxes can unexpectedly turn out to be complex"
Except for stamp duty, tax planning in the acquisition, disposal, or development of property is often relegated. However, there are various other taxes resulting from property transactions.
One such is Value Added Tax (VAT) on the sale of improved land, which is charged at a rate of 18 percent of the transaction amount. For instance, if person “A” sells improved land at Shs100m, that transaction attracts a VAT of Shs18 million. What is important to note is that there is a thin line between unimproved and improved land. Anything physical and visible to the eyes of an intending purchaser of land qualifies as an improvement. For example, if one buys a chunk of land, subdivides it, creates access roads, and extends water, or power to the plots, even if still vacant, the land is considered to have been improved and attracts VAT charge.
The other is Capital Gains Tax (CGT) which is charged on the sale of business assets. To be classified as a business asset, either the land has to be owned by a company, and for individuals, it must be used or held ready to be used in a business. If an individual’s tax profile shows that that individual’s business activities include real estate, it will be inferred that the purchase or sale is a business transaction. It becomes incumbent upon the individual to prove to URA that the asset sold or bought is not a business asset.
It should be noted that whereas residential property does not attract tax, once turned into commercial use, upon disposal, it attracts CGT. For instance, if you purchased a residential property for your dwelling in 2020 at 300million and later, you rented it out as office space - that converts it to a business asset. Assuming it is sold at Shs450 million, the chargeable income is Shs150 million minus any capital expenditures made on the property. CGT is charged at a rate of 30 percent. To hedge against inflation and ensure that capital gains triggered by inflation are not computed in the CGT calculation, the law allows for consumer price indexation of the cost base to align it to the real value of the asset at disposal.
Relatedly, there is rental income tax which is charged on rent derived by a person or company from letting out an immovable property (land and/or buildings). The rental income rate applicable to individuals is 12 percent of annual gross rental income above Shs 2,820,000. No deductions are allowed. The tax rate applicable to companies is 30percent of chargeable rental income, subject to allowable deductions. These are capped at 50 percent and are limited to only expenses directly incurred to earn that income (they must not be capital in nature). These allowable deductions are subject to URA verification. Rental income tax is segregated/separated from any other income.
Arithmetically, it is illustrated as follows: if for example, an individual earns Shs4,820,000 per annum, he/she deducts Shs 2,820,000 and remains with Shs2 million as chargeable income, which is charged 12 percent to create a tax liability of Shs240,000. However, for a company, if, for example, it earns a rental income of Shs100 million per annum, it can deduct expenses of up to Shs50 million. The payable tax becomes 30 percent of the remaining Shs50 million. However, if the allowable deductions are only Shs10 million, then, the tax payable is 30 percent of the remaining Shs90 million.
Although not a tax, it is befitting to mention that anybody who purchases a business asset must act as a collecting agent and withhold tax at a rate of 6 percent on the gross payment made to the seller.
The key takeaway is that real estate taxes can unexpectedly turn out to be complex. For any real estate transaction, it is wise to analyse it from the perspective of its tax implications to avoid any surprises.
The author, Mr Allan Atwiine is a lawyer & tax consultant. [email protected]
