22nd October 2015
Structuring Your Investment Property Portfolio
Building an investment property portfolio is an exciting and rewarding process and one that most Australian’s aspire to build throughout their life time.
In doing so, there are many things that need to be considered such as Asset Protection and Tax. Getting your structures right and using the right Investment vehicles along the way will play a critical role in both protecting your wealth and minimising your tax, thus maximising your investment return.
In this blog we’ll go through a few of the structures available to building an investment property portfolio and how they affect you.
Owning investment properties as an individual is usually a good idea for your first investment (possibly more, especially if it includes Units). As an Individual you are entitled to a Land Tax Threshold (currently sitting at $432,000 in NSW) before you are required to start paying Land Tax. We generally recommend clients first look to fully absorb their Land Tax threshold before they start looking at other vehicles (such as trusts and companies) to invest in property. You could also argue that an individual should be looking interstate to invest in property once they’ve absorbed their NSW Land Tax threshold, this way they can use the thresholds applicable in each individual state before using alternative structures.
Individuals are also entitled to a 50% Capital Gains Tax (CGT) discount provided they have owned the asset for a minimum of 12 months when the property is sold. At the highest marginal tax bracket this makes the effective tax rate 24.5% which is lower than the corporate rate of 28.5% (companies are not entitled to the 50% CGT discount)
One thing this structure doesn’t provide much of however is Asset Protection. Potential litigators that intend to sue you personally could potentially go after every asset owned in your name, as can trustees in bankruptcy.
Discretionary Trusts (Family Trusts)
Discretionary Trusts are a great Asset Protection vehicle, mainly due to the fact it is difficult for potential litigators to establish that any one person has a fixed entitlement on the assets owned by the trust. That said however, multiple properties owned under the one trust could all be subject to a claim where that litigator is a tenant or lender for the property concerned. Furthermore, provided the ultimate beneficiary of any Capital Gain is an individual, the 50% CGT discount would still apply giving the effective CGT rate of 24.5% (if at the highest margin rate).
However, we generally recommend using Discretionary Trust structures to invest in property once you have absorbed your Land Tax thresholds in the state you wish to invest. The reason being is because Discretionary Trusts are defined as ‘Special Trusts’ and not entitled to the Land Tax Threshold. Therefore, if you were to make your very first investment property purchase through a Discretionary Trust you would be liable to pay Land Tax on the full land value (if that land value was $400k the annual Land Tax assessment at current rates would be $6,500 – this would be an extremely expensive asset protection strategy if you had multiple properties and were forgoing Land Tax Thresholds)
On another note, we often get asked the question if you can buy your Principal Place of Residence through a Discretionary Trust. The answer to this is yes, however you would be forgoing any Capital Gains Tax Exemption on the sale of your home. The ATO states that only Natural Persons are entitled to the Main Residence Exemption, and for the purpose of this definition a Trust or Company is not considered a Natural Person. Again, this would potentially be an expensive Asset Protection strategy.
Owning investment properties through a company often requires a bit of number crunching to determine if the benefits would outweigh the previously mentioned structures. The main reason being is a company is not entitled to the 50% CGT discount mentioned earlier, therefore the corporate tax rate of 28.5% would apply to any gain, which is 4% higher than the maximum rate applicable to the Individual structure.
However, if you owned one investment in your personal name in NSW (which absorbed your Land Tax threshold) it could be a viable option to use a company structure for your second investment property. The reason being is because companies are also entitled to a full Land Tax threshold, so any extra amount you end up paying in CGT could end up being less than the year on year Land Tax savings over the ownership period. It should be noted however, you won’t be able to open multiple companies to own multiple properties because there are Related Company provisions which capture this kind of arrangement.
In terms of Asset Protection, assuming you would be a Director/Shareholder in the company then any potential litigators against you personally would still be able to make a claim on the value of the properties as the shares in the company are where the value sits. However in terms of Asset Protection against the actual properties themselves (say a tenant hurts themselves and wants to sue the Landlord and your Insurance isn’t adequate OR perhaps a lender) then the litigator will only be able to sue to the extent of the companies assets, i.e the property in question (assuming no other guarantees are provided).
If your property investment portfolio includes Negatively Geared properties then the Trust and Company structures may not be suitable. Companies and Trusts cannot distribute losses, they must be quarantined. So unlike the Individual structure where the losses can offset your other income (namely employment income) and realise an immediate tax benefit, you’ll need to wait to receive those benefits for a Trust or Company.
Also, the costs of setting up a trust or company and then ongoing administration costs also need to be factored in when comparing potential tax savings versus an individual structure. If the costs outweigh the savings then the strategy needs to be reconsidered.
Finally, owning property through an SMSF also has considerable benefits however that requires a Blog of its own – watch this space.
This article is general in nature and should not be relied upon in making an investment decision. We strongly recommend you seek financial advice prior to making any investment decisions.