It’s often said that to get far in investing through property you have to know what you want to achieve before you take the plunge – whether the end goal looks like a round dollar figure or a springboard into your next purchase.
In saying this, the vehicle in which you choose to buy a property within, should not only be based on your future goals but also be an equal match to the type of property you buy.
Wayne Jessup, property investing coach and director of The Property Bloke, shares that you are only essentially able to base your buying strategy on your current circumstances and what you visualise could happen over a five-year timeframe.
“You can’t really see too far into the future because no one really knows, but you can put a [buying] structure in place that’s going to work,” Jessup says. “Especially if it’s a tax effective structure, you have got to get it right from the beginning.”
It comes down to being aware of your objective and what you require of your asset base in order to achieve what you want, he adds.
“Therefore, you can buy in the correct way, otherwise you will end up investing for five years and potentially lose hundreds of thousands of dollars by being under the wrong tax structure,” Jessup explains.
Investors are heavily anchored towards reducing their tax check, but on some occasions, they won’t reap the full potential of the tax deductibility of their property because their structure doesn’t effectively bolt into their personal circumstances.
Paul Wilson, director of Income2Wealth, says, “I see people come through with structures where they want to have a tax benefit but the tax benefit ends up being quarantined in the structure and not to the person”.
What is the purpose of the investment? – It’s the golden question that Wilson always comes back to.
“If [the investor is] someone on a high income trying to reduce their tax obligation, that will influence the type of property that they buy and it will also influence the structure that they do it within. Because there is no one size fits all,” he shares.
Buying property under your personal name
Understanding the timeframe of your investment, its purpose, and the strategy you adopt –– whether it’s a sell or hold approach – will collectively influence the buying structure.
Clive Nelson, partner at Chan and Naylor, states that purchasing property in your personal name(s) is the most commonly utilised structure; particularly in NSW and VIC.
“Tax is paid at your marginal rate of tax on the net rental income, and capital gains tax is payable in the event that the property is sold for a gain, with a 50% concession for property that is held for 12 months or more,” Nelson says.
People generally choose to purchase in their own name because it’s more straightforward when they are starting out in property, Wilson from Income2Wealth says.
“They’ve got the deductibility because they can have the negative gearing benefits of depreciation and it also offers them the ability to reduce their wage, build an asset base, and reduce their tax – so often that is the motivation,” Wilson explains.
While some investors might feel the need to set up a different structure in order to better protect themselves, Wilson proposes that at times “it might be like peeling an egg with a sledgehammer”.
“They maybe put structures in place that are excessive to the initial purpose and the needs that they have,” he explains. “If it is a deduction so that you can claim less tax personally then you want that in your personal name.”
Jessup from The Property Bloke highlights that buying property in your personal name can give you access to long-term benefits once you sell.
“But the problem with that is it depends on how you are investing,” he says. “You also have land tax to be considered as well – each state has a different amount of land tax.”
Nelson from Chan and Naylor notes that this varies for certain development projects. “If you acquire land only and subsequently construct a dwelling then you only pay stamp duty on the land portion,” he says.
Buying property within a company structure
While purchasing in your name and holding a property for a year opens you up to a substantial tax deduction in the sale profits, a company structure has a flat tax rate of 30%.
“There is no capital gains tax benefit if you hold it longer than 12 months, so whether you hold it for one month or whether you hold it for 10 years, you will always pay 30% tax,” Jessup warns.
Because of this, a company structure might work well for investors who plan to purchase and sell their properties in under 12 months; such as a developer executing a swift buy, flip and sell.
Nelson from Chan and Naylor offers another instance in which a company structure could be effective. “The company tax rate may be lower than a person’s marginal tax rate if the property is ‘tax positive’,” he states.
The land tax threshold concession may also be a benefit, Nelson adds.
But considering that the property becomes an asset of the company rather than of the individual, Wilson from Income2Wealth says that a lender could require a personal guarantee for the loan.
“[Lenders] are not just going to lend to a company that has limited liability,” he explains.
Buying property within a trust
A trust structure holds the “benefit of distribution for the minimisation of tax”, Wilson shares.
This means that it allows trustees to distribute the profits and consequently diminish the overall amount of tax that needs to be paid.
However, Jessup from The Property Bloke says that investors need to be aware of the overall costs of operating a trust, which includes an establishment fee.
“[The costs] have got to be worthwhile,” he says. “You wouldn’t want to do it just for a smaller property, you would probably want to buy a bigger property to put it under a discretionary trust.”
While Nelson from Chan and Naylor says that a trust structure is attractive for those who also desire “anonymity” and “asset protection”, there are a few different types of trusts that are on offer and each one comes with varying benefits and obligations.
Buying property jointly with a spouse
Jessup from The Property Bloke advises investors to understand how the ownership of a property should be effectively shared between a couple.
“Especially with a negatively geared property and especially if it’s a brand new property with depreciation, the majority ownership should be in the higher income earners name,” he shares.
The proportion of the property that each individual should own can range from 50% up to 100%, or even down to 0%, Nelson from Chan and Naylor says, and the right balance will partly be determined by “the taxable nature of the property, the taxable nature of the individual, their land tax threshold, and their personal risk perspective”.
However, Wilson from Income2Wealth says that he often sees people “become stuck” when they purchase property jointly with a party that they are not in a relationship with, such as a friend or colleague.
“They might be able to get a loan and get into a property but what they don’t realise is the long-term implications on serviceability on each other,” Wilson explains.
“[The lender] will assume that all of the debt is yours and they will also assume that all of the debt is mine,” he proposes. “But they will only give half of the income to you, and only half of the income to me, so both of our [future] serviceability become significantly impacted by that.”
Buying property within a self-managed super fund
There are tax rewards when purchasing property within a self-managed super fund (SMSF). Not only is the taxable income capped at 15%, but pension income within the SMSF is tax free once you enter your retirement years.
“This also includes any capital gain on the disposal of investments,” Nelson from Chan and Naylor says. “In the situation that you hold a negatively geared investment property in the SMSF, the loss on the investment property offsets other income including contribution income.”
A SMSF is a “great vehicle for tax minimisation”, Wilson from Income2Wealth says. But he also shares that funding is becoming harder to obtain and the loans are more expensive.
Those who are self-employed are able to own a commercial premise and rent it back to themselves, Wilson adds. But amongst some of the other restrictions, this benefit does fall over to residential properties.
Wilson also shares how the power of your equity can become compromised in a SMSF: “If you had equity in that property outside of [your SMSF], you can use that equity as a deposit and leverage to buy more assets, but with the super fund, your money is trapped in that asset and you can’t borrow against the equity.”
Furthermore, Nelson from Chan and Naylor states that there could be the additional cost of potentially having to establish a “stand alone” trust, as well as the cost to meet with a “financial planner or an authorised representative of a registered financial services organisation” – who can determine whether a SMSF is best suited to your goals.
Overall, buying property under an effective structure boils down to conducting the appropriate research.
“Get some professional advice before you buy a property; it’s a big decision every time, so you have got to make sure that you [purchase] it the right way,” Jessup from The Property Bloke shares.
There’s a lot more strategic planning involved when establishing a trust in order to build a tax-savvy asset base.
Clive Nelson, partner at Chan and Naylor says, “getting the ownership structure of a property right can ensure the optimal tax benefits and getting it wrong can prove to be very costly to correct”.
Nelson states some of the benefits of buying property under a trust, and a few things for investors to be mindful of also:
- A trust is an attractive option when a person is seeking anonymity, asset protection or potentially a tax effective investment strategy.
- The amount of tax you will be required to pay under this buying structure will depend on the type of trust and the nature of the investment.
- The main types of trusts, excluding the superannuation environment, include: a discretionary, which is often described as a ‘family’ trust; a unit trust; and a hybrid trust, with one variety being the property investor trust.
- Rather than an individual or a few individuals being on title as the trustee, we generally recommend a company is on the property in the capacity as trustee of the particular trust.
- Taxable income can potentially be distributed to family members in a lower tax bracket, and negative gearing benefits are also achievable with the appropriate trust.
- There are usually costs to open a trust, as well as a company establishment cost for a trustee company.
- “Consulting an experienced property tax accountant would be the appropriate start,” Nelson advises.