There are several very important decisions to make prior to contracting to purchase real estate. The specific location and hand-picking a suitable property are understandably the primary focus, but what name to buy the property in also requires proper consideration.
In a lot of cases, buying a property in personal names might be the most suitable. But it is not a one-fits-all solution. Everyone’s circumstances are different.
When weighing up one’s own pros and cons, the two most important considerations generally relate to the level of importance that one places on:
- a) managing taxation, and
- b) protecting assets from potential litigation.
To help people to better understand, Propertyology invited financial advisor Joshua Lee from Link Wealth to elaborate on the options available.
Owning property in your own name (or jointly with another person) is by far the most common way people own property.
It’s a very simple structure and one that doesn’t cost money to set up.
As a property investor, you can benefit from negative gearing (when rental income is lower than property outgoings, producing a loss that can be claimed against regular income).
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You also are eligible for the 50 percent capital gains tax (CGT) concession if the property is sold greater than 12-months after buying it.
For some investors, a potential downside of personal ownership is that any annual net profits and capital gains from sale do get taxed at your individual marginal tax rate. Which can be up to 47 percent.
This structure provides no flexibility or asset protection.
A family trust structure is known for its flexibility as you have discretion on distributing income through the trust to the beneficiaries (typically family members).
Annual net income and capital gains are still taxed at the individual beneficiary’s tax rate. However, a trust provides the ability to distribute income in a more tax efficient manner.
The 50 percent CGT concession still exists for this structure. Although it’s important to understand, owning a principal place of residence (family home) through a trust will lose the main residence exemption.
It is commonly advised not to hold your principal residence in a trust structure (always seek personal advice on your individual situation!).
Besides tax efficiency, trusts are also incredibly popular for asset protection purposes, especially for business owners as they are recognised as a separate legal entity and can provide protection from creditors or lawsuits (providing a corporate trustee structure is utilised).
The trust structure is a little more complex to set up and requires an accountant or lawyer, as well as an accountant for tax returns each year.
Annual land tax expenses are also higher for trusts than individuals, so this definitely needs to be taken into consideration.
If you incur a loss on your property (negatively geared scenario), the loss is trapped within the entity — meaning that you cannot distribute the loss directly to any individual beneficiary. However, this loss can be used to offset any other income that is made in the trust (eg. dividends from shares or a business).
Company structures for investing are less common, but well known for their maximum tax rate of 30 percent. This is clearly beneficial for those in higher tax brackets.
This structure is also beneficial for asset protection as its own separate legal entity, similar to a trust structure.
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Similar to trusts, company structures require an accountant and lawyer to help set up the entity, and ongoing costs, including land tax, will be higher overall.
Annual income losses are trapped within the company structure (you cannot distribute them to an individual).
A major downside to a company structure is that you are not eligible for the 50 percent CGT concession. This should be weighed up against the flat tax rate of this structure.
A self-managed superfund (SMSF) has several similarities to trusts and company structures in that they are more costly and complex to set up and maintain.
SMSF generally provides good asset protection.
If an income loss is incurred, it is trapped within the SMSF structure.
Where an SMSF becomes interesting is that the income generated is taxed at 15 percent, which is the most tax-friendly environment in Australia.
Capital gains are also taxed at 15 percent. And, if the asset is held for over 12 months, the SMSF is eligible for a 1/3 discount, bringing the tax rate back to 10 percent.
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If you are over the age of 60 and meet a retirement condition of release (or retire), the SMSF asset can be sold tax-free.
As can be seen above, there are various pros and cons with each structure.
The costs to undo a structure after the event can be significant.
It is important to seek professional advice relating to your own situation to ensure you get it right from the beginning.
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