Garden Route Investment Properties & Holiday Accommodation, South Africa

Ruling your properties from the grave

Is bequeathing a right to occupy a home for life good estate planning, or "ruling from the grave"?

MoneywebTax expert Steven Jones analyses the pros and cons of a usufruct.

A member of the congregation I serve as minister recently tried to pick my brain on a "habitation" she was having difficulty with. Thinking at first she said "haberdashery", and about to tell her I knew nothing about sewing, I thought better of it and asked for clarification. All was revealed when she handed me a legal document headed "Notarial Cession of Habitatio", better known to tax practitioners and estate planners as a usufruct.

Is bequeathing a right to occupy a home for life good estate planning, or "ruling from the grave"?

MoneywebTax expert Steven Jones analyses the pros and cons of a usufruct.

A member of the congregation I serve as minister recently tried to pick my brain on a "habitation" she was having difficulty with. Thinking at first she said "haberdashery", and about to tell her I knew nothing about sewing, I thought better of it and asked for clarification. All was revealed when she handed me a legal document headed "Notarial Cession of Habitatio", better known to tax practitioners and estate planners as a usufruct.

Now just in case anyone is shocked that a minister could use such foul language, allow me to explain: A usufruct is where an owner of a property grants another person legal rights to occupy such property.  It is a device often used in estate planning, particularly in the case of elderly married couples, and can result in the saving of estate duty.

The situation that a usufruct seeks to address is as follows: A couple have a home, and because they are getting on a bit in years, they ultimately want to leave their home to their adult children. The property could of course be left to the surviving spouse, who would in turn bequeath it to the children, but this will result in a potentially larger estate duty bill when the surviving spouse dies, since the house will have probably gained value by the time it passes to the children. Conveyancing costs will also end up being paid twice.

One answer is of course to bequeath it to the children upon the death of the first-dying spouse, but the problem is that the surviving spouse will still need somewhere to live. A usufruct provides the solution, since it is a mechanism whereby the ownership in the property (known as the bare dominium) may be bequeathed to the children, but a legal right of habitation (the usufruct) is granted to the surviving spouse.

While the children become the owners of the property, the estate duty liability is greatly reduced because the usufruct, which needs to be valued, passes to the surviving spouse free of estate duty, while the bare dominium is no longer the full value of the property but the difference between the property value and the value of the usufruct.

A usufruct is valued by multiplying the value of the property by a pre-determined value (published by Sars) based on life expectancy, and then taking 12% thereof.

The following example illustrates how this works:

• Mr A has a property worth R2.8m at the time of his death. If he bequeaths it to his children, estate duty of R560 000 will be payable (assuming that the R3.5m exemption has been used by other assets). If he leaves it to his wife, there will be no estate duty payable, but her estate will then be liable for the estate duty on 20% of what is likely to be a higher value.
• However, if Mr A leaves the property to his children subject to a usufruct in favour of his wife (who is assumed in this example to be 65 years old at the time of his death), the value of the usufruct is R2 298 781 (R2.8m x 6.84161 x 12%), which is exempt from estate duty as it is left to the surviving spouse. The bare dominium, which is left to the children, is only worth R501 219, resulting in an estate duty liability of R100 244 - a substantial saving.

This estate planning seems so obvious that everyone should be making use thereof.  Not only does it result in a considerable saving in estate duty - it also provides a measure of protection to the surviving spouse who enjoys the use of the property for the rest of his or her life.

That is, of course, assuming that the surviving spouse actually wants to stay there for ever. This is not always the case, as this particular situation indicates. The property in question was bequeathed to seven relatives jointly, subject to a usufruct in favour of the surviving spouse. Now while joint family ownership of property can often lead to tears, this particular arrangement is quite harmonious.

However, the surviving spouse now wishes to emigrate. Since she has no particular financial interest in the property, her feeling is that she should be able to simply relinquish her right to the usufruct, thereby allowing the holders of the bare dominium unencumbered ownership therein.

Enter Sars.

One cannot simply give something away - that something needs to be valued, and if the value exceeds R100 000 (assuming no other donations), the donation is subject to donations tax at 20% of the amount exceeding R100 000. In this particular case, what the surviving spouse is giving away is the remaining value of the usufruct, which now has to be calculated on the current value of the property.

Since the woman in question is 72 years old, and the property is now worth R800 000, the value of the usufruct is now R564 480. Subtract the R100 000 exemption, and she's left with a donations tax bill of R92 896. Needless to say, she doesn't have this kind of spare cash lying around idle, just to hand over to Messrs Manuel and Gordhan!

However, if she leaves the usufruct in place and emigrates, not only are there potential capital gains tax implications (since one is deemed to have disposed of all of one's assets upon ceasing to be a South African residence for tax purposes, although in this case the R1.5m primary residence exemption comes into play), but the holders of the bare dominium may not dispose of the property while the usufruct remains in place.

One option is to relinquish the usufruct simultaneously with the disposal of the property, and have the bare dominium holders pay the donations tax out of the proceeds on the surviving spouse's behalf. This would in itself be regarded as a donation, although if it is split seven ways, and the donors have no other donations in that tax year, it could be an exempt donation. However, cash flow-wise the sellers are still down 93 grand.

This scenario illustrates the danger of trying to rule from the grave. Unless there is an absolute guarantee that the surviving spouse intends to live in the property for the rest of their life, a usufruct can cause more bother than it's worth. With the general estate duty exemption now at R3.5m, such a device does not make sense for the average Joe as a means of trying to save estate duty.

For more about usufructs and your property investments, read: Property owners: Get out of paying CGT Capital Gains Tax, usufructs: get through the complex rules and you won't be hit with this nasty tax - expert.