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How home office deductions impact Capital Gains tax

August 23, 2021

Remote working and flexible employment have really taken off in the last year and a half. Perhaps we can categorise this as one of the very few ‘pros’ we’ve seen coming out of the Coronavirus pandemic.

This kind of employment involves workers working part or all of their time from an at-home office. Of course, the most obvious upside to this is eliminating the daily commute, thereby increasing a healthy work-life balance – there is more opportunity to get to the gym, make an early dinner, and help your kids with their homework.

But what kind of effect will this have on your tax deductions, and does it impact Capital Gains tax? Let’s take a look below:-

Tax deductions

Home office expenses do qualify as a tax deduction if specific criteria are met. Reducing our taxable income is always a bonus, but it’s essential to know the tax rules around home office expenses and what you are allowed to deduct. These rules don’t apply to sole proprietors or established freelancers who have always worked from home.

But for those just moving into the remote or flexible working fields due to the pandemic, here’s what you need to know and what is required for home office deductions and expenditure:

  • A letter from your employer is needed, showing that they have allowed or instructed you to work from home.
  • The individual must spend more than half of their total working hours working in the home office.
  • The individual must have a separate area that is used exclusively for business. It can’t be used as an office during the day and double up as a dining room in the evening.
  • The space must be equipped for your specific business or trade, including printers and other work tools.

What expenses can be deducted?

Suppose the individual is a commission earner (earning more than 50% of total remuneration from commission). In that case, they can deduct: rent, interest on the bond, repairs to the premises, rates and taxes, cleaning, wear and tear, and all other expenses relating to their house and related business expenses like internet, telephone, stationery, repairs to computers, etc.

In contrast, salaried employees can deduct rent, interest on the bond, repairs to the premises, rates and taxes, cleaning, wear and tear, and all other expenses relating to their house only.

How would you calculate the home office deduction?

One would need to work out the total square meterage of the home office in relation to the total square meterage of the house and then convert this to a percentage. This is then applied to the home office expenditure to calculate the portion deductible as business-related.

Although there are benefits here for home office tax deductions, few people know that it can have a negative impact on your capital gains tax when you sell your property one day.

How do home office deductions impact Capital Gains Tax?

Individuals are entitled to a primary residence exclusion of up to R2 million to offset the capital gain arising on sale. However, if part of your primary residence is used for business and a deduction is claimed for trade expenditure, this part of your primary residence is then not covered by the exclusion. This means the individual may be exposed to Capital Gains Tax because the overall capital gain will need to be apportioned between a primary residence and business use.

Let’s take a look at an example from the South African Institute of Taxation to illustrate the point:

Isabel purchased a home in February 2007 for R1.2 million. In February 2015, she carried out renovations for R300 000 to add on an office from where she worked until she sold her home in February 2019. The office space made up approximately 10% of her total house space (i.e., it was 10 m2, while her entire home was 100 m2) and she therefore claimed 10% of her house running costs as a tax deduction against her business income.

She lived in this home until February 2019 when she sold it for R3.5 million. Her taxable income for 2019 was R500 000.

THE CAPITAL GAINS CALCULATION

Proceeds: R3 500 000

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

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

Portion of the capital gains attributable to the property’s use as a home office (10% for 4 years out of 12 years): R2 000 000 × 4/12 × 10% = R66 666

Portion of the capital gains 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
Total capital gains: R66 666
Less: annual capital gains exclusion: R66 666 – R40 000 = R26 666

The inclusion rate for capital gains is 40% for individuals. This means that 40% of the gains (i.e., R26 666 × 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 × 36%).

If Isabel had not used part of her residence as a home office, the capital gains tax on the disposal of her property would have been nil due to the primary residence exclusion being applied to the total gain of R2 million.

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

Note that on Isabel’s ITR12, she must report the details of the property sale as two separate transactions. This is done by indicating in the opening wizard that two disposals took place. This will open up two capital gains/loss sections so that the details of each can be captured separately. For the primary residence exclusion to be correctly applied, she must pro-rate the proceeds and the base cost for each disposal, so as to reflect the primary residence portion separately from that of the non-primary residence portion.

Consider the experts

Need to find out more about how working from home is impacting your tax or the home office deductions you are allowed to claim? Give us a call, and we can help you through the process. Dirmeik Consulting has an extensive understanding of tax and VAT laws and can give the correct and up-to-date advice on all your tax matters. We make sure to keep up to date with any new rules or regulations made by SARS.

Dirmeik’s tax experts can advise on all South African tax matters and endeavour to create the best solution for you and your business. Get in touch with us on our website.


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