I’m buying an investment property, what is the best structure?
When you decide to buy an investment property, the first question you ask your tax adviser is “what is the best tax structure for my investment property?”.
Unfortunately, there is no ‘one-size-fits-all’ approach and which particular tax structure is best for you and your property investment depends on a number of variables.
Asset Structuring issues to consider
If you are in an ‘at-risk’ occupation or run a business, you generally avoid holding assets personally, however, this means that you may have to forgo the negative gearing benefits of direct personal ownership.
Negative Gearing vs Positive Gearing and Investment Property Structure
Whether an investment property will be positively or negatively geared is relevant to the choice of structure.
Net rental losses from an investment property may be offset against income from other sources, for example, if you held an investment property directly you can apply those losses against your salary and wage income. However, if an investment property is held by a company or trust:
- unless the entity has other sources of income, there is nothing to apply the net rental losses against;
- the losses are trapped in the entity and do not flow out to shareholders or beneficiaries; and
- the losses may be applied against future income (subject to various loss tests).
Further, if the investment property will be negatively geared, how long you expect it to remain so is another relevant factor. For example, the disadvantages of having losses trapped in a trust over the short-term may be outweighed by the ability to stream rental income and capital gains over the medium to long-term.
Availability of the 50% CGT discount (Capital Gains Tax)
Subject to various conditions, individuals and trusts are eligible for the 50% CGT discount whereas companies are ineligible for CGT discount. Therefore, it is generally preferable to hold capital assets directly or through a trust.
NSW duty issues
NSW has introduced a number of changes relating to ‘foreign persons’, that is:
Duty Surcharge relates to purchases by foreign persons, including:
- any individual (other than Australian citizens) not ordinarily resident in Australia (200+ days in 12 months); and
- any company or trust in which one or more foreign persons holds a substantial interest (20%+).
Critically, despite the fact that technically, a beneficiary of a discretionary trust has no ‘interest’ in the trust at all, all beneficiaries are effectively deemed to have a substantial interest in the trust such that the (Australian) trust is treated as a foreign person for present purposes.
Duty Surcharge is now 8% (on top of ordinary duty of up to 5.5% for properties over $1m and 7% for residential land over $3m [premium property duty]), that is, total duty of up to 15% may apply to foreign persons!
Therefore, in relation to acquisitions of NSW property through trusts, you should carefully consider:
- how any new trust deed is prepared, for example, does it specifically exclude any distributions to beneficiaries that would cause the trust to be a foreign person for present purposes?
- if you plan on acquiring the property in an existing trust with other assets, for example, shares, should you:
- maintain the status quo knowing that it will be a foreign trust for duty purposes but allowing you to continue to make distributions to beneficiaries who are foreign persons; or
- amend the trust deed to prevent any distributions to beneficiaries who are foreign persons for duty purposes, which would also prevent any distributions of other trust income to foreign persons as well.
Whether or not a trust deed can be amended and the tax and duty implications of same (if any) must be carefully considered prior to proceeding.
NSW land tax
Land tax is generally levied annually at $100 + 1.6% of the relevant value over the land tax-free threshold (“Threshold”), where available.
The current (2017) Threshold is $549,000 (Valuer-General value not ordinary market value).
There are various issues to consider in this context:
- does the particular structure facilitate access to the Threshold?
- if so – is the benefit of the Threshold at the entity level maintained in flowing up the chain of ownership?
- is the owner a foreign person such that the land tax surcharge applies at the rate of 0.75% (for 2017) and 2% (2018 onwards).
Broadly, individuals, companies and fixed trusts are eligible for the Threshold, whereas discretionary trusts are not. However, a trust that is commercially understood to be a fixed trust will not necessarily be a fixed trust for land tax purposes (which has very rigid requirements).
Further, even if a trust is fixed for land tax purposes and the Threshold is available at the trust level, the benefit of the Threshold may be effectively reversed out at the beneficiary level where the beneficiary is:
- ineligible for the Threshold; or
- eligible for the Threshold but already has other NSW real property interests over the Threshold.
Finally, foreign persons will be subject to the land tax surcharge even if ordinary land tax does not apply because:
- the value of the land is under the Threshold (i.e. land tax surcharge applies from the first $1 even if the taxpayer is eligible for the Threshold in relation to ordinary land tax); or
- the principal place of residential exemption applies (with certain exceptions for New Zealand citizens holding Special Category Visas who are ordinarily resident in Australia).
As you can see, there are a number of issues to consider when deciding how to structure your investment property for tax purposes. See here for a table on some of the key considerations when buying an investment property in NSW – Structuring Options Table
Of course, if you are considering an investment property in another State or Territory, their particular duty and land tax consequences must be carefully considered but overall, the issue is not what the ‘best’ structure is but what best for you in the particular circumstances.
If you or your clients need any assistance for this or any other tax issues, let’s talk!
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Disclaimer – This article is general in nature and does not constitute, and cannot be relied upon, as providing specific advice.