Property investors beware
Property is, in my view, a great investment but you gotta get it right! Here’s a trap that you hadn’t thought of –
Let’s say your company buys a property using a 10 year bond on which the repayments will be R10 000 per month and the rental income is R10 000. Ignoring everything else, the cash flow is zero right? Wrong! Of that R10 000 bond repayment about R9 000 is deductible interest and R1 000 is capital repayment which is not deductible, so the company will be in for tax on R12 000 in the first year, which is R3 360. Not a train smash.
But in the 10th year, the interest will be say, R1 000 and the capital repayments R9 000. That’s a whopping R108 000 taxable income attracting R30 240 tax and the rent is still just making the bond repayments. So where’s the money to pay the tax coming from?
Fortunately, your rental agreement has an escallation clause, so the rent went up by maybe 6% each year whilst the bond repayments stayed the same (assuming no change in interest rates). So your rental income will be R16 895 per month and not the R10 000 that it started as. Take off the R1 000 interest expense and the tax will be on R15 895 per month or about R200 000 for the year. That’s R76 000 tax and your rental income for the year is almost R80 000 more than your bond repayment, so you’ll just about have the cash available to pay the tax as long as you didn’t spend it!