Kenya’s real estate sector continues to record commendable growth which is expected to continue in the foreseeable future. This growth has mainly been driven by increased government investment in infrastructure and demographic trends such as the rapid urbanization which is among the highest in the world.
Investors have taken note of the above factors and have tailored their developments to make use of the emerging real estate theme of mixed-use real estate which incorporates both residential and commercial use. In this article, we explore the key taxation aspects of mixed-use real estate.
Income tax on rental income
The Income Tax Act (ITA) provides for taxation of income arising from any right granted for the use or occupation of property, be it commercial or residential property. However, following changes to the ITA in 2015, different rules apply when it comes to calculation and remission of the same.
Income tax on commercial property
A proprietor (individual or company) of commercial property is expected to declare the rental income when filing their annual returns.
In this annual regime, the proprietor is entitled to deduct expenses which are wholly and exclusively used in the generation of the income such as: land rates/rent, insurance, agent’s fees, security costs, fees for general repairs and maintenance, and amounts paid as interest on loans utilized in purchasing or constructing the commercial property.
In addition, the proprietor is also entitled to take advantage of investment allowance and make a deduction in the calculation of tax payable equivalent to a percentage of the cost incurred in the construction of the building (excluding cost of the land).
The tax thereon is paid in instalments which are due for payment on or before the 20th day of the 4th, 6th, 9th and 12th months after the year end. The balance of tax is payable by the end of the 4th month after the year end.
Income tax on residential property
A proprietor (individual or company) of residential property has two options when it comes to filing their rental returns. They may opt to file under the simplified regime which was introduced by the Finance Act 2015. Under this option, the proprietor is simply required to file and remit 10% of the gross residential rental receipts without any deduction whatsoever. To qualify for the simplified regime, the gross receipts of the residential income must exceed KES 288,000 but be less than KES 15,000,000 during a year of income.
In the case where the residential rental income exceeds KES 15,000,000 during a year of income, then the proprietor would be required to file under the annual regime effectively subjecting them to a 30% tax on the taxable income (after allowable deductions). Alternatively, a proprietor who would otherwise be entitled to file under the simplified regime may in writing apply to the Commissioner for exemption from the regime.
Income tax on mixed-use residential property
Due to the different tax regimes applicable to the two separate incomes as highlighted above, proprietors who have mixed-use real estate are usually advised to separately account for the two different incomes. While this approach is logical, several questions may arise when it is comes to computing the tax payable.
To illustrate, if a proprietor has a mixed-use building comprising of commercial space occupying the first 3 floors and residential space in the remainder of the building, pertinent questions would arise in the computation of the tax payable in respect of commercial space as to how to apportion costs such as land rates/rents, agents fees, loan interest and investment allowance which would not all be rightfully attributable to the commercial space.
While there is no specific formal guidance which has been issued as to how to go about the same, the second schedule which provides for restriction of deduction of investment allowance calculated as the expenditure attributable to the portion of the building which is used for the allowed purposes offers guidance as to a possible route for apportionment of the expenses in question.
Uncertainty continues to cloud the computation of tax payable when it comes to mixed-use real estate. Therefore, it is critical for taxpayers to reach out to their tax consultants to ensure that they have reasoned cause of action.