Tax Incentives

Selective and intelligently designed tax incentives can play a major role in absorbing private sector capital for urban regeneration. Unlike the non-tax-based incentives noted (density bonus, up-zoning, development rights transfers), tax-based incentives involve an indirect exchange of funds between the public and private sectors. The tax incentives could be given to private sector developers or to individual residents of a neighborhood to foster area-based regeneration. In order for tax-based incentives to work properly, a city must have a strong and clear planning regulatory framework and tax collection system.

Traditionally many of these incentives (especially in the United States in the 1980s) started to close the gap between the cost of development in inner cities and the value of the development after construction. They have been widely used in the United Kingdom as enterprise zones, which were primarily structured as a job creation tool in distressed neighborhoods. However they have had moderate success in developing vacant and underused land. Enterprise zones allocate tax exemptions and ease some planning regulations to increase business in distressed areas. Another example of this is the urban development zone (UDZ) in South Africa, which is a tax incentive program launched by the Ministry of Finance and implemented by local municipalities. This national-level law allowed the municipalities to designate UDZs around the “areas of priority” listed in their integrated plans, or areas where “significant fiscal measures have been implemented by that municipality to support the regeneration.” Johannesburg was one of the first cities in South Africa to start using this program in 2004, and the UDZ included its inner city area. The particulars of this tax incentive are detailed in box.

Urban development zone tax incentives in Johannesburg, South Africa

The urban development zone (UDZ) tax incentive works in the form of an accelerated depreciation from eligible taxpayer’s taxable income—if this income is a result of erection, extension, or improvements of, or an addition to an entire building or part of a building within the central business district (CBD) that is at least 1,000 square meters. The incentive also applies to the purchase of buildings within the CBD with said criteria from a developer, if the developer has not yet claimed any UDZ allowance.

The UDZ incentive distinguishes between construction of new buildings and refurbishment of existing ones. In the case of full or partial improvement of an existing building, the UDZ deductibles are equivalent to

A five-year straight-line depreciation or 20 percent of the total cost in the year of assessment, during which the building is brought into use by the taxpayer solely for the purposes of trade.
An amount equal to 20 percent of the cost in each of the four succeeding years of assessment, provided that the person engages in continuous use of the building solely for the purposes of trade.

In cases of erecting or extending an existing building, the deductions follow these rules:

Twenty percent of the total cost in the year of assessment, during which the building is brought into use by the taxpayer solely for the purposes of trade
Five-percent of the cost for the 16 subsequent years of assessment conditional to continuous use for the purposes of trade

The UDZ tax incentive is especially attractive to investors because the tax deductibility of costs can be offset against the investors’ entire income and not just the income resulting from investment in buildings. For example, assume that a doctor who generates R 500,000 in income purchases a townhouse within the UDZ and spends R 50,000 to rehabilitate the property. He then rents the townhouse and earns R 36,000 a year in rental income, of which R 34,000 are spent on ongoing costs of maintenance, resulting in a net profit of R 2,000. The R 50,000 tax credit would be applied against the entire income of R 502,000—that is, the R 500,000 income received as a doctor plus the R 2,000 townhouse rental profit.

The city has praised the UDZ tax incentives as a driving force behind the surge in real estate investments in the inner city in 2005 and 2006. However, it is difficult to analyze the impacts of UDZs independent of all other initiatives that were simultaneously in place. By 2011, more than 200 UDZ applications had been filed with the city of Johannesburg. The city claims to have attracted R 2 billion in private sector investment to the inner city per year and about R 9 billion within the 2010–11 financial year (Garner 2011). Although some smaller-scale development companies have complained about the cumbersome bureaucracy of UDZs, of the 200 UDZs filed, 90 were by smaller development companies. In addition, it is estimated that 65,000 construction-related jobs were created as a result of the UDZ tax incentives (Garner 2011).

The UDZ regulations and conditions have been amended several times since their inception to make them more practical and useful. One important change was the 2005 amendment, which allowed the UDZ benefits to be extended to sectional title ownership. This change resulted in a greater uptake of the incentive by the general public and streamed the benefits from the developers to the buyers of the units. Another amendment has allowed for a 25 percent depreciation (over a period of four years) for the construction of low-cost, high-density affordable housing. Finally, the UDZs are now allowed to include developmental leases by the government to the private sector (Garner 2011).

Source: “Urban Development Zone,” City of Johannesburg. Johannesburg, http://joburg.org.za/index.