Don’t lose that tax loss!

From departure to encashment
January 25, 2024

Sustaining losses on certain activities, blissfully assuming that SARS will chip in at year-end? Make sure that this loss is not ‘lost’ forever.

Many people have invested in second properties based on the knowledge that, for the first few years at least, they would have to fund the shortfall until such time as the rents escalated to a level whereby a profit would be shown.

In fact, given the massive increase in property prices over the past 20 years, many such investors didn’t even care that they were losing money on a monthly basis, since the capital gains would more than compensate for this loss. Besides, with the good old taxman chipping in part of the shortfall, the refund at the end of the year made even large losses somewhat more palatable. This is because SARS allowed you to set off your rental losses against your other income, thereby reducing your tax bill by up to 45% of the loss sustained on the rental property.

Section 20A was introduced into the Income Tax Act in 2005, which has the effect of disallowing such set-off of losses. Instead, the losses sustained are to be carried forward to future years, where they can only be set off against income earned from the same trade. For example, if your rental property made a loss in 2022, this loss can only be set off against profits made on the property in 2023 or later years.

This has resulted from a long-standing concern by the tax authorities regarding the practice, carried out mainly by high-income earners, whereby certain so-called ‘suspect trades’ that were in many cases disguised private expenditure sustained losses, which the taxpayer then sought to set off against other income.

However, this provision only applies to losses sustained from the following activities, listed as ‘suspect trades’ in the Section:

  • Sporting activities;
  • Dealing in collectibles;
  • Rental of residential accommodation (unless at least 80% of the accommodation is used for at least half the year by non-relatives of the taxpayer);
  • Rental of vehicles, aircraft or boats (unless at least 80% of these assets are used for at least half the year by non-relatives of the taxpayer);
  • Showing animals in competitions;
  • Farming or animal breeding (unless the person carries on these activities on a full-time basis);
  • Any form of performing or creative arts; and
  • Gambling or betting.

The Section also only applies to natural persons who pay tax at the maximum marginal rate of 45%, which means that if your taxable income is less than R1.87 million per annum, Section 20A does not apply to you.

The rule also applies only to any trade that has sustained losses in at least three of the five years ending on the last day of the year of assessment (the ‘three-out-of-five’ rule).

You will also not be subject to the provisions of this Section if you can prove that your trade was carried out in a “commercial manner”, and that there is a prospect that your venture will become profitable within a reasonable period of time.

SARS has issued specific guidelines to be followed in determining whether a trade is carried out with a “commercial motive” (see table above).

Fortunately for many taxpayers, Section 20A was not made retrospective, and since the provision only came into effect from 1 March 2004, any loss carried forward from a previous year of assessment is ignored. However, this means that the first year of assessment in which the ring-fencing provisions were applicable was the tax year ending 28 February 2007, i.e. 16 years ago!

If your particular activity is not able to meet any of the criteria set out in the Section to exclude it from the ring-fencing, do not despair. If this activity starts showing a profit in future years, you will be allowed to deduct the ring-fenced losses against those profits generated.

On the other hand, if you have embarked on a venture that does not make commercial sense, hoping that someday you might, by some stroke of fortune, actually make some money from the venture, you could have a long wait before those losses can be set off against income.

And if you dispose of the asset or discontinue the venture in the meantime, those losses may be ‘lost’ forever.

While every reasonable effort is taken to ensure the accuracy and soundness of the contents of this publication, neither the writers of the articles nor the publisher will bear any responsibility for the consequences of any actions based on information or recommendations contained herein.  Our material is for informational purposes.

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