As with different investment strategies, there are numerous ways you can structure the purchase and ownership of your property assets.
It’s advisable that you seek professional guidance from an experienced property investment expert around the best type of structures for your specific requirements, as this isn’t a “one size fits all” proposition.
For starters, different structures will come with different associated tax repercussions and some will be more advantageous than others, depending on why and how you’re investing in property.
Furthermore, how you obtain finance, along with the level of security your asset base benefits from as it evolves and provides an income into retirement, will all largely hinge on how you structure your property investment portfolio.
This is a something you should aim to get right when starting out on your investment journey, because it can be costly and tricky to untangle a messy ownership structure.
These are generally the most common ownership structure associated with residential real estate, as most of us will acquire a home in our own name (or names if in a relationship) and it’s by far the easiest way to transact property.
The only extra cost for property investors is your accountant’s fee at tax time.
While the benefit is that you maintain complete control over the property, the payoff is that the asset is exposed to any litigious action should someone decide to sue you. In other words, the courts can force you to liquefy real estate assets.
Plus if you hit a financial rough patch and default on your financial commitments to say, a credit card company, they can make a claim on any assets in your name to repay outstanding debts…including property you own.
From a tax perspective… the benefit of individual property ownership for investors is that you gain the full negative gearing advantage at tax time, particularly if you happen to be in a higher income tax bracket.
On the flipside, income tax will apply (at a marginal rate) to your property portfolio when it transitions at retirement and starts to produce positive cashflow for you to live on.
Is similar to individual ownership and can be done one of two ways, as either:
Joint tenants – often used by owner-occupier couples who then both own a half share of the property. If one person dies, full entitlement over the asset automatically defers to the living owner on title.
From a tax perspective… income and expenses are split evenly across both parties, which makes this a very basic and not necessarily effective ownership structure.
Tenants in common – means you own whatever portion of the property as agreed on between all parties to the purchase. The total delegation of shares must add up to 100%. If one person dies, ownership transfers according to the terms of their Last Will and Testament.
From a tax perspective… This can be a good way for couples to divvy up the asset according to who might be the higher income earner, thereby reducing their combined tax loss by reducing the larger debt through optimal use of negative gearing entitlements.
Companies and Family Trusts
Hardcore property investors who are in it to generate serious wealth will often have some or their entire portfolio structured in such a way that their assets are legally owned by a company/companies and/or trust(s).
These entities are a lot more complicated to establish and administer and therefore, generally come at what can be a quite significant cost.
A trust is a legal arrangement whereby control of the property investment is transferred to the nominated trustee, for the beneficiaries’ benefit.
In other words, the trust buys the property and the trustee distributes any profits to you and your nominated family members at its discretion – the beneficiaries. They are then required to pay tax at their marginal rates on the disbursement received.
A trust deed is created that declares who can appoint a trustee and the actual person appointed in this role, and it’s up to that trustee to determine who to distribute the profit to, in accordance with this deed. Typically trust dividends are disseminated on June 30 each year.
Taking it a step further you can also create a company to be appointed as a corporate trustee. As the company director, you have more control over how profits are apportioned and when you die, who gets to take the reins of the trust.
Many investors, particularly those in so-called ‘high risk’ professions where litigation is common (e.g. medicine) – use these structures to shelter their assets from direct threat should someone decide to sue them.
Rather than being in an individual name and exposed, the property investments are not technically owned by the investor, but the entity that acquired the real estate in the first instance – the trust or company.
Given the costs associated with establishing and maintaining these structures, they certainly are not for everybody.
Establishing a trust or company for investment purposes is generally most beneficial for self employed high-income earners, or those who have already been accumulating property in their own name for some time and require a more secure and tax effective structure.
Trusts or companies cannot be created for the sole purpose of avoiding taxes either, and family trusts can’t distribute any losses, which negates the potential to claim any negative gearing entitlements on real estate in this structure.
Self-Managed Superannuation Funds (SMSF)
Self Managed Superannuation Funds are gaining a lot of ground in Australia…where workers have historically relied on traditional managed super funds to do all the heavy lifting when it comes to providing a retirement income.
When the 2008 GFC demonstrated that you couldn’t rely on others to plan for your future financial – even in something as seemingly benign (in terms of risk/return weight) as superannuation, more people began taking the reins of their own ‘nest eggs’.
Now the industry is worth over $500 billion in this country and the SMSF structure is proving increasingly popular among property punters, largely due to the attractive associated tax benefits, including:
- In the accumulation phase, your SMSF can purchase income-producing property (using borrowed capital up to an LVR of 70% and fund balance of $120,000 plus), with any profits taxed at a capped rate of 15%. Unlike traditional tax rates applied to property related income at the investor’s own marginal rate.
You also enjoy limited CGT liability, where any gain realised on property owned for 12 months or more by the SMSF is taxed at a maximum rate of 10%.
- When you reach retirement and your portfolio starts to provide an income to replace your weekly paycheck, your fund converts to its pension phase. At this time, the income from your super becomes entirely tax-free; meaning no CGT liability and no income tax at all for SMSF owned property assets.
- Your SMSF can claim negative gearing and depreciation benefits associated with property holdings (depending on the type, age and state of the asset), thereby reducing the 15% tax rate further and potentially creating a tax free environment in some instances.
Of course the payoff is that you cannot claim any negative gearing or depreciation entitlements to offset your own personal income tax if your SMSF owns the property investments, plus these structures can be quite convoluted and costly to establish and administer.
Although limited recourse borrowing has opened up the SMSF structure to more mum and dad investors, allowing funds to borrow capital for the acquisition of residential or commercial property, you still need a minimum balance of $120,000.
Plus your fund needs sufficient liquidity to repay the loan, as well as maintain the investment. And it’s worth noting that you’re restricted in terms of what you can do with property held by SMSFs, in terms of redevelopment for instance.