Question: My wife and I would like to borrow 90% LVR to buy an investment property. We’re thinking of using some equity from our PPOR to pay for the 10% deposit and other costs. The loan on our home is under both our names. I’m the higher wage earner, so should I claim all the costs including LMI? What’s the most tax-effective way to structure the investment property loan?
Answer: The deductibility of the interest is determined by two things.
The first is: What did you use the money for? In this case it was used for an investment property and hence the interest is deductible.
The second is: Whose name is the title of the property in? This is as opposed to the name on the loan document. If you are the higher tax payer, then the property title should be in your name. The 90% loan should also be in your name. The 10% loan, which is in joint names, would still be deductible as long as you satisfy items one and two above.
However, it’s much more complicated than this because we have only considered the short-term consequences of income tax. What happens when the property becomes positively geared in a few years’ time? You will then end up paying income tax at your marginal tax rate, and should you try to change the title to your wife, who is on a lower tax bracket, then there will be stamp duty and capital gains tax on this transfer.
Have you considered the land tax implications? The state in which you are purchasing the investment property will determine the required structure, as some structures entitle you to a separate land tax threshold. You can avoid land tax totally if you structure yourself correctly.
Maybe a property investors trust is more appropriate to your circumstances, since it will allow you to claim the income tax deductions in the short term in your name, and, should you want to transfer the positive gearing to your wife in the future, there is no stamp duty to pay – only some CGT.
At least this will allow you the opportunity to work out the income tax savings of transferring the property to your wife’s name versus paying the CGT. If there was a financial advantage, you would then consider it.
If the property was held in your name, the costs of stamp duty and CGT would prohibit this opportunity. It also gets you a separate land tax threshold in most states of Australia, except NSW.
So if you already have other properties in your name and a further property pushes you above the land tax threshold, then a property investors trust will get you another land tax threshold, saving you potentially up to $6,000 a year in land tax.
If you are in an occupation that is highly litigious (doctors and business owners), holding an investment property in your own name is rather dangerous as you could lose the property to a creditor.
A property investors trust will provide you with asset protection because a creditor is unable to force the unit holder to liquidate their units and only the trustee of the trust is permitted to redeem the units. If you have your spouse as the other trustee, either in her own capacity or in her capacity as a director of your trustee company, then you will get almost full asset protection.
It’s important to consult with an accountant who specialises in this area to properly determine your circumstances. It sounds simple but you can’t look only at short-term income tax deduction, as most accountants do. What you do today will affect you tomorrow and it’s very expensive to make changes once you’ve bought the property.
You must consider the long-term consequences such as capital gains tax, stamp duty, long-term income tax, asset protection and so on.
A property investors trust gives you the flexibility to change as your circumstances change.
Also, unlike other trust deeds, it does not have a ‘vesting date’, meaning it does not dissolve automatically after 80 years, triggering stamp duty and capital gains tax to either you or to the children who may inherit your properties.