In What Entity Should You Buy Your Property?
When it comes to buying property, whether for investment purposes or otherwise, there are a lot of decisions to be made. What area to buy in, whether to buy an apartment or stand-alone home, whether to consider a new home or a fixer-upper; these decisions will all come down to your goals for the property. Another decision that needs to be made is just what entity to purchase the property under, also referred to as the ‘property investment structure’. If you’re a first-time investor, this consideration may not even have occurred to you. If you’re more experienced when it comes to investing in property, you may still find that the decision over ownership of the property is a little confusing. After all, the final verdict will have an impact on not only the property’s ownership, but the taxes applicable to the purchase and sale of the property, and even the finance that’s available to you. In this article, we take a look at the different structure options you have when it comes to property ownership, and help to demystify the decision for you.
Individual: The most common and cheapest way to purchase a property is as an individual. This might include purchasing the property with a partner or a spouse, in which case, both names will appear on the loan documents and other paperwork. The benefits of purchasing as an individual (or with a partner) is that the loan process is simple, and there are less fees associated. There may also be attractive tax incentives available to individuals who purchase investment property. Of course, there is a downside to this structure. When purchasing as an individual – that is to say, without a company or a trust involved – your financial and legal responsibilities are not limited or protected. This means that the individual owners of the property are liable legally for the property. For example, if you were to be sued, you (and your partner) would be liable for the outcome.
Buying as an individual can be a great option for many high-income earners, if the property is negatively geared, as it can lower taxable income. Individuals may also be eligible for the 50% CGT discount.
Joint names: Buying property in a joint venture has a couple of key advantages. For starters, it allows friends or associates to pool their funds in order to purchase investment property. This lowers the barriers to getting into the market, as you can combine your funds for a deposit on the property. It also means that you can apply jointly for a loan on the property, and should be able to afford more than you would be able to if buying as an individual. Once again, there are downsides to this type of structural arrangement. Firstly, if no formal agreement is in place with regards to the ongoing costs of the property, things can be a little tricky. Doing business with friends may seem like a great idea, but when it comes down to paying to replace the hot water system, disagreements can arise. The most important thing to do is to have an agreement in place which clearly outlines who is liable for what costs, and to what percentage. For example, you might agree that each of the two parties is responsible for 50% of the mortgage payments, as well as 50% of all ongoing costs. You may, of course, come to another arrangement which suits you best (where one party puts up a higher deposit amount, in return for being less liable for ongoing expenses). Be sure that all parties are clear on their rights and obligations to avoid later conflict.
Company: One way to limit your legal and financial liability is to purchase property as a company. A company may attract a lower rate of tax on any net rental income from the property, and individuals will be protected from liability, to an extent. The negative aspects of buying property include not receiving the 50% CGT discount, that capital can be hard to access (for example, to purchase further properties) and that any losses incurred can only be deducted from future income. Furthermore, a company can be quite expensive to set up and maintain.
Trust: Trusts, like companies, can protect the legal and financial liabilities of the parties involved. A trust is a legal entity set up to manage assets for the trusts’ beneficiaries, and if set up properly, can offer a way to protect their assets. Although, they can be complicated and expensive to set up, just like a company. While a trust is often eligible for the 50% CGT discount, it cannot claim the first home buyer’s grant, and cannot be used to claim losses against taxable income. Meanwhile, it can make the dividing of profits and assets easier, when the time comes.
For those wishing to have extra asset protection, a trust can be a good solution. However, for negatively geared properties, a trust may not be the way to go, as the losses cannot be deducted from personal income tax and therefore remain within the trust.
Self-managed super fund (SMSF): Finally, purchasing property through a self-managed super fund has become more popular in recent years. Pooling your superannuation assets with other parties, as with a partnership or joint venture, means that your borrowing capacity is increased. Using your superannuation to purchase property can also save you from having to come up with a cash deposit. It should be noted however, that purchasing property in a SMSF structure is subject to strict government guidelines. For starters, the investment must meet the ‘sole purpose’ test, which determines whether the investment is in the best retirement interests of the parties involved.
The benefits of buying property through a SMSF include being able to pool assets, offset tax (tax on superannuation is 15%, and only 10% after the asset has been held for 12 months) and reduce taxable income by making pre-tax contributions, and having greater control over your superannuation investments. The downsides include not having a personal interest in the property (for example, not being able to rent to or sell to a relative), not benefitting from negative gearing, and having your super tied up in a fairly non-liquid asset. Furthermore, the purchase can be costly and complicated to organise.
Which structure should you choose?
Depending on your long-term plans for the property, there may be several options open to you when it comes to structuring your property investment. While it might be easier and cheaper for married couples to borrow together, there can be certain benefits to borrowing in one partner’s name or the other, for tax reasons. On the other hand, for those wishing to limit their liability and protect their interest in other assets, a company or trust structure might make the most sense.
As this issue is very complex, it is important to seek advice from your accountant, mortgage broker and solicitor. Being aware of the benefits and drawbacks of each structure, as well as what your borrowing capacity will be under each, will help you to make the most informed decision for your property investment.