Do Reit distributions qualify for the Sars interest tax exemption?

This is a common point of confusion for many investors, as the taxation of Reit distributions operates quite differently from the tax treatment of regular interest or dividends. It is a critical distinction to understand for effective tax planning, particularly for those building an income-generating portfolio.

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To answer your question directly: unfortunately, no – Reit distributions do not qualify for the Sars interest tax exemption. The distributions you receive from a Reit cannot be used to offset the annual exemption of R23 800 for individuals under 65, or R34 500 for those 65 and older. This is a fundamental principle of the South African tax system, and it is vital to know why.

Understanding the conduit principle

The primary reason for this is the unique tax structure afforded to Reits by Sars, which operates on a ‘conduit’ or ‘flow-through’ principle. Unlike a typical company that first pays corporate income tax on its profits before distributing dividends, a Reit is generally not subject to corporate income tax on the distributions it makes to its shareholders. For this tax-free status to apply, the Reit must distribute at least 75% of its taxable income to shareholders each year.

The tax liability therefore passes directly from the Reit to you, the individual investor.

This means the income is taxed at your personal level, not at the company level. This is a critical difference from standard company dividends, which are exempt from income tax in the hands of the individual investor, because the company has already paid corporate tax, as well as the current 20% dividends withholding tax levied at the company level.

A deeper look at the tax classification

While a Reit’s distribution may feel like a dividend, Sars classifies it as a distinct form of income. It is treated as taxable income in your hands and is subject to your marginal income tax rate. This is explicitly stated in the Income Tax Act. The distributions are not seen as interest income as defined by Sars for the purposes of the interest exemption.

The interest exemption is specifically designed for income derived from sources such as bank savings accounts, fixed deposits, or money market accounts. These are instruments where the income is directly classified as interest. A Reit’s income, however, is a blend of rental income and other property-related earnings, which, when distributed, is simply classified as income to the shareholder.

Read: Do Reits offer a tax break if you’re in the 41% bracket?

For example, let’s consider two investors, one with a fixed deposit and another with a Reit investment, both earning R30 000 in a year. The investor with the fixed deposit, under the age of 65, can utilise the full R23 800 interest exemption, leaving only R6 200 of their interest income to be taxed at their marginal rate. In contrast, the investor receiving R30 000 from the Reit must declare the full R30 000 as taxable income, and no portion of it is exempt.

This illustrates the importance of understanding the different tax treatments of investment income.

What this means for your tax return

When you receive your IT3(b) tax certificate from your financial institution, you will notice that Reit distributions are reported separately from interest and dividend income. Sars has a specific source code (4238) for distributions from Reits, which ensures that it is correctly allocated as taxable income on your tax return. In contrast, local interest income has its own source code (4201), which is linked to the automatic application of the interest exemption.

In summary, when you receive a distribution from a Reit, the full amount must be included as part of your total taxable income on your personal income tax return. The income is then taxed at your individual marginal tax rate, with no portion of it eligible for the local interest tax exemption.

For investors seeking to build an income portfolio, this distinction is fundamental to calculating your after-tax returns and ensuring you are compliant with your tax obligations.

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