When you are interested in purchasing investment property or any investment asset for that matter, you should consider whether you are purchasing the asset in an appropriate structure. If the appropriate structure is not established from the start, it can end up being very costly, and restructuring may not be a viable option.
Structuring your investment property purchase
Unfortunately, there is no ‘one structure suits all’ approach to owning an investment. You should consider several factors when making any investment decision, including the following:
- Asset protection
- Income tax efficiency
- Ability to borrow within the structure
- Tax efficiencies on disposal of the asset
- Succession planning
Popular structures for holding investment properties include:
- Ownership in an individual name
- Ownership in a family discretionary trust
- Ownership in a self-managed super fund
Investment properties are commonly held within these structures as they are entitled to the general discount on any potential capital gain generated where the asset is held for more than 12 months. A company structure does not enjoy such a concession. For individuals and trusts for example this may result in any capital gain being discounted by 50% and you only pay tax on half of the gain.
These structures should be reviewed in light of your long-term goals if you are planning on purchasing an investment property or similar asset.
Protecting your assets in an investment property purchase
For example, a young doctor starting their journey in the medical field will see their circumstances change both professionally and personally. They may start out employed as a registrar in a practice and continue in this position for some years before moving into a role where they operate as a sole trader. If they do start operating as a sole trader, they may expose their investment assets to risk if litigation is brought against them personally. Their investment property could be exposed as a personal asset. If they have a spouse, who may have a lower risk profile or generate lower assessable income each year, that may support the notion of acquiring the property in their name.
Alternatively, they could consider holding any investments in a protected entity such as a family trust, which also gives the flexibility to potentially direct income to various family members. Each year, the trustee can resolve to distribute the income and any capital gain on the potential disposal of the property to beneficiaries as they see fit. As an extra level of asset protection, a company could act as a corporate trustee of the trust.
This can also assist with potential succession planning, as individuals such as adult children can be added as directors of the company, allowing them to take effective control over the trust. This is unlikely to result in transfer duty, whereas if you held the property in your own name and transferred it, they would likely incur transfer duty on the transaction.
Positive or negative gearing?
Another consideration when making an investment property purchase is whether it is positively or negatively geared. Positive gearing refers to the situation where the income received from the assets (the rent collected) is greater than the costs of owning that property. Conversely, negative gearing occurs when the income is not sufficient to cover the costs of maintaining the property. Depreciation for tax purposes can also result in an even larger loss.
As an individual, negative rental losses can be offset against your employee, business or other income, which can help reduce your tax. There may therefore be a benefit in holding the property under your name as an individual if asset protection issues and other factors are not a concern. If you are generating a higher income than your spouse, you will likely see better tax savings each year, holding it in just your own name or if you hold the greater percentage. However, there is no flexibility to divert any capital gain; rather, most of the gain will be taxable in your name, where you may be paying the top marginal tax.
In a trust structure, any tax losses incurred due to the negative gearing are not able to be distributed to beneficiaries. The benefits of negative gearing would not be realised each year and rather carried forward to offset future income in the trust. If your trust also invested in other investments that were positively geared, such as shares and dividend income, then the rental losses could be offset against this.
Purchasing investment property through your SMSF
Self-managed superannuation funds can also be utilised to purchase properties. There are additional complexities and regulations around holding properties in self-managed superfunds, and borrowing within this structure can be challenging. This structure is often used to take advantage of the lower tax rates and concessions once you meet the pension phase. You should seek financial advice on whether a self-managed super fund would be appropriate in your circumstances.
As mentioned above, the best way to purchase investment property will depend on your personal circumstances, income, risk exposure, and long-term plans. There are a lot of different details that need to be assessed to make the most out of your investment.
Whether you’re starting to explore how to purchase investment property or are ready to do so, your structure will play a critical role in outcomes. If you are considering purchasing an investment property, contact a William Buck advisor to determine an appropriate structure for you.
