Many people requests that the rights in a property they bequeath be split between their beneficiaries, conferring limited real rights therein to some and the residual interest or bare dominium in the property to others. For example: In Peter’s will, he leaves the house to his son, Jack, but bequeaths the life long usufruct in the house to his wife, Cathy. One of the reasons for this is to make sure that his wife (Cathy) will always have a place to stay or have something that provides an income. But what Peter may not realise is that his attempt to provide a source of income for his wife may give his son a CGT headache.
CGT is levied on capital gains arising on the disposal of an asset when the proceeds from the disposal are greater than the base cost of the asset disposed of. When a usufruct is imposed on an asset, the asset is regarded as having been partially disposed of and its base cost is split between its bare dominium and the usufruct. The bare dominium will have a much lower base cost than the original asset had. When the usufruct expires, the rights relating to the usufruct pass to the bare dominium holder but his low base cost remains unchanged. A very large capital gain may thus arise when the former bare dominium holder who now has full ownership rights disposes of the restored asset.
To Clarify: Assume that Peter’s house has a current market value of R1 million for which he paid R500 000. In his will, he leaves the house to his son, Jack, but bequeaths the life long usufruct in the house to his wife, Cathy. Cathy is expected to die in seven years’ time.
On his death very shortly afterwards, Peter is deemed (in terms of the Income Tax Act 58 of 1962) to have disposed of the property to his deceased estate at the market value of the property at the date of death. In the hands of Peter’s deceased estate, the base cost of the house is allocated in the following manner:
Market value: R 1 000 000
Base cost of the usufruct*: R 678 000
Base cost of the bare dominium: R 322 000
In terms of the Income Tax Act, the base cost of assets in a deceased estate is carried over to the heirs when they receive the assets. Thus Jack will receive the bare dominium in the house which has a base cost of R322 000 and Cathy will receive a usufruct in the house with a base of R678 000.
As Cathy ages and the usufruct heads towards expiry, the market value of the bare dominium Jack received will increase in value but the base cost will remain the same. When Cathy dies, the usufruct passes to Jack. The house thus regains its full value of R1million (assuming property prices have remained the same over the seven years) in Jack’s hands but the base cost is still R322 000. So if Jack then sells the house for R1 million, he will have a capital gain of R678 000.
Had Peter not imposed any usufruct over the house in his will, Jack would have inherited a house with a base cost of R1 million. If Jack thereafter sold the house for R1 million, he would not have any capital gain on disposal and he would not have incurred any CGT.
There are other methods that Peter could have used to make sure that his wife will be cared for and that his son receives the house at Cathy’s death and by side stepping CGT.
* The Income Tax Act provides for a method for the valuation of a life usufruct in an asset upon the death of the original owner. The method involves determining the present value of the annual right of use in the usufructuary property over the expected life of the person receiving the benefit.
(Jaco Bekker) 