Legal entity structures for property portfolios

[Dingus]

Hi All,

Question for the experienced masses...

I currently have two properties and looking to buy a third (or 3 more in the next say 6 years in various states) and was looking to house these investments in an investment vehicle of some sort. My reason for doing so is tax minimisation as well as setting up something for my retirement and future generation, with my investment strategy being more buy and hold at this stage.

Going through the numerous vehicles out there (companies, trusts etc), there does not seem so be one that fits my exact specifications. Either it costs me now (lost deductions) and saves me later (CGT / income distribution), or saves me now in tax and may potentially cost me later (stamp duty / land tax / asset protection).

I wanted to post this to get a gauge of what other people have done in terms of their own property portfolios and why you chose to go that route (ie companies, trusts etc). It seems that there are alot more people with bigger portfolios than mine so it would be interesting to see what structures and issues people have faced in their scenarios...

Cheers,
Matt

 

[Terry_w]

You have a wide variety of ownership structures and structure of structures to consider.

The owner of the property doesn't necessarily need to be a 'trust'.
eg. buy in low income earners name and dump cash into the offset.
e.g buy in Vic in name A and then sell to name B (no stamp duty) once there has been some capital growth.. Use proceeds to pay off PPOR debt = indirectly making PPOR dedutible.

e.g. borrow money from spouse on low income and use this as deposit for invesmtent property - diverts income to spouse for interest you pay. (seek legal advice on this).

e.g. gift to a discretionary trust and borrow back allowing the trust to take second mortgage.

or combine all the above - after getting proper advice!

 

[tj22]

in vic you can give between spouses with no stamp duty. can you do the same for a family member? father to son etc?

 

[Terry_w]

in vic you can give between spouses with no stamp duty. can you do the same for a family member? father to son etc?

no. And i would suggest you don't gift... sell at full market value.

 

[Paul@PFI]

Of course all structuring decisions should factor in today and what may happen in many years time. Thats the impossible "crystal ball" problem and one of the trust features can be retention of that option - To change your mind later. But it can come with catches.

Consider estate planning too.

One of the popular strategies for LONG TERM HOLD that gives great tax outcomes is a structure that allow a SMSF to be a part-investor in future years. A unit trust can suit that. Sure it may have a loan secured today and a SMSF cant be involved but perhaps in 5, 15 or 20 years ??? Buying in personal names is a nail in the coffin for that strategy if its resi property. This strategy needs to consider your existing super, proposed super strategies (ie salary sacrifice ?), spouse , family friends and more. Its more financial advice than anything. It doesnt suit some and suits others well. Often its a age based strategy for those 40's +

It can be used to access untapped equity in other IPs and allow these properties to be refinanced and YOU access personal tax deductions through negative gearing while building super over the pre-retirement phase (ages 45-58)...So the low rate super is taxed on +ve income and the high rate taxpayer gets -ve gearing.

The lure ?? 0% CGT and 0% tax on super income (share of rent etc) and personal negative gearing.

If you arent sure what I refer to happy to talk.

 

[coastymike]

Sure it may have a loan secured today and a SMSF cant be involved but perhaps in 5, 15 or 20 years ??? Buying in personal names is a nail in the coffin for that strategy if its resi property.

If you transfer to a unit trust and wait 3 years then the coffin opens. Of course the disadvantage of not adopting the unit trust on inception are the extra stamp duty and cgt implications.

 

[Dingus]

Thanks for the reply Paul, indeed it is a crystal ball problem!

It may be that I am borderline Gen X/Y or otherwise brainwashed (I am 31), but Super and SMSF doesn't seem an attractive option for me... agree that it can provide some great tax savings in the future but that means no access to money for another 35-40 years the way things are currently going.

Are there many people out there that have used companies for an investment vehicle (obviously income tax and retained income being the win for a company)?

 

[coastymike]

Thats the advantage of having property in a unit trust from inception. It allows you to keep the asset outside of the super environment and as you approach retirement have the opportunity to move it into a tax friendly environment.

Lots of strategies for minimising the cgt on redemption and issue of units. In many cases if planned properly the cgt may in fact be mitigated. Then you have moved the units across into an smsf and after 60 a tax free income stream and any future capital gains also income tax free.

The costs of doing so with the asset in your own name either prevents it or moving it into a unit trust with the associated costs and waiting three years.

Also miss out on the ability to move the units around if necessary and take advantage of the refinancing principle.

Companies as a vehicle for holding capital assets e.g long term buy and hold. A terrible vehicle. Lose the 50% cgt discount and issues getting the money out. Avoid.

 

[Feradd]

Companies as a vehicle for holding capital assets e.g long term buy and hold. A terrible vehicle. Lose the 50% cgt discount and issues getting the money out. Avoid.

Do you also have a zero threshhold for land tax if properties are held in companies or trusts?

 

[coastymike]

It depends on the State.

 

[Terry_w]

I did a consult yesterday for someone who wanted to buy in companies.

His idea was that the company can retain income and cap the tax at 30%.

I pointed out 2 problems:
1. No CGT discount
His argument was that no intention to sell. So that won't be an issue.
My counter arguement was that circumstances change and CGT would apply eventually when the shareolder dies and the beneficiaries sell the shares, wind up the company etc

2. Income changes its character - a CG in a company will come out as inncome. No an issue in most cases but a family member could have capital losses which could have been be used to offset the gains if owned by a discretionary trust.

One advantage of a company over a trust is a new land tax threshold in NSW. But unfortunately you can't keep opening companies because for land tax purposes they can group related companies together.

 

[Paul@PFI]

Companies as a vehicle for holding capital assets e.g long term buy and hold. A terrible vehicle. Lose the 50% cgt discount and issues getting the money out. Avoid.

Almost always agree. I'm thinking exceptions and the small business concessions can be easier to access when the property is an active asset rather than a passive. Also a company useful where land is trading stock eg a developer or a property "empire" entity and asset quarantining is a strategy to limit risks. Really needs a broad base of shareholders to warrant it. Then a Widely Held Trust may be better anyway. Thats a clever strategy for Doctors and other groups of professionals,

I cringe when the client walks in and explains that 20 years ago dad setup a co and it owns property worth $xxx,xxx +... Dont think I have ever seen one of those without a Div7A problem too. Its like the family smsf but its far from a SMSF. Even pre-CGT land and property in a company can be a serious concern. (Whats pre-CGT land I ask in vain ?)

For small business I dont see a benefit of a company as, if the tax rate is zero in a SMSF, I still dont see the benefit of the small business CGT concession. In my experience, I find having the property in a SMSF gives access to the "contribution + rent" benefit....Paying rent and contributions means the fund growth is maximised. Strategy is once members are 55+ to max the pension, max the revalution each year, max the rent annually too and max salary sacrifice. A SMSF on steroids.

 

[Dingus]

Apologies if these are obvious questions...

Could you please elaborate on how a Unit Trust would be used as an investment vehicle? And how it could link in with a SMSF in later years? I thought if you transfer any units down the track you would be up for stamp duty as well as CGT?

With regards also to Land Tax, I understand you can nominate a beneficiary and apply their thresholds, however if you are a beneficiary and you have exhausted your threshold allocation (through properties in individual name) how can the Trust then have additional threshold? Or does it mirror the beneficiary threshold?

 

[Terry_w]

Apologies if these are obvious questions...

Could you please elaborate on how a Unit Trust would be used as an investment vehicle? And how it could link in with a SMSF in later years? I thought if you transfer any units down the track you would be up for stamp duty as well as CGT?

With regards also to Land Tax, I understand you can nominate a beneficiary and apply their thresholds, however if you are a beneficiary and you have exhausted your threshold allocation (through properties in individual name) how can the Trust then have additional threshold? Or does it mirror the beneficiary threshold?

Trustee of the unit trust purchases property on behalf of the beneficiaries under the terms of the trust deed. A unit trust is a trust in which unit holders have fixed entitlements to the income and/or capital of the trust. The beneficiaries are unit holders. A unit holder could be a person, a trust, a company or a SMSF.

Transferring units could result in stamp duty (0.60% in NSW) but some states do not have stamp duty onn the transfer of units/sharess. It may also be possible for a trustee to redeem units and to issue new units bypassinng stamp duty. Transfer of units would be a CGT event.

Land tax varies greatly from state to state. In NSW no threshold for a trust. It is not possible to nominate a beneficiary either, but if the trust is a fixed trust (not all unit trusts are fixed) the the unit holders will be considered owners for land tax purposes so the individual may get the threhold if they have not already utilised their threshold.

In QLD the situation is totally different wth a trust getting a separate threshold.

 

[Dingus]

Just been doing a bit of research for an investment vehicle and am looking at Hybrid Trusts... seems to mix the benefits of discretionary and unit trusts.

What are everyone's opinions on Hybrids (apart from increased cost of setup and increased ATO scrutiny)?

For me it seems to allow interest deductions for me as I plan to buy units from borrowed monies and then allows future beneficiaries to receive income on a discretionary basis before distribution to unit-holders.

 

[Terry_w]

Just been doing a bit of research for an investment vehicle and am looking at Hybrid Trusts... seems to mix the benefits of discretionary and unit trusts.

What are everyone's opinions on Hybrids (apart from increased cost of setup and increased ATO scrutiny)?

For me it seems to allow interest deductions for me as I plan to buy units from borrowed monies and then allows future beneficiaries to receive income on a discretionary basis before distribution to unit-holders.

Set up costs would be the same. Depending on the terms no interest or oly partial interest would be deductible to the unit holder. The trustee must have no disretion over income or capital while the units are issued.

saying the word "hybrid" to a lender makes them poo their pants. It can also be difficult to find a lender that will allow title in name A but loan in name B. St G are generally good at this - but the lending issues can hold you back.

 

[Dingus]

Set up costs would be the same. Depending on the terms no interest or oly partial interest would be deductible to the unit holder. The trustee must have no disretion over income or capital while the units are issued.

saying the word "hybrid" to a lender makes them poo their pants. It can also be difficult to find a lender that will allow title in name A but loan in name B. St G are generally good at this - but the lending issues can hold you back.

Thanks Terry, personal lending won't be an issue as I am drawing down on existing equity for deposit... but I will be borrowing within the Trust for the property itself.

Can you elaborate on the interest deductibility (partial depending on trustee income and capital discretion?). Does this similarly apply to a vanilla Unit Trust?

 

[Terry_w]

Thanks Terry, personal lending won't be an issue as I am drawing down on existing equity for deposit... but I will be borrowing within the Trust for the property itself.

Can you elaborate on the interest deductibility (partial depending on trustee income and capital discretion?). Does this similarly apply to a vanilla Unit Trust?

The basic principles of deductibility are that for the interest to be deductible it has to be borrowed for income producing investments/business. But it also has to be a commercial arrangement.

So would you borrow to to invest in a rental property where there is no right to receive rent? or no right to receive Capital gains?

Or to invest in a trust where the trustee could give the income and/or capital gains to someone other than yourself?

Probably not! So the ATO has released a ruling about 7years ago which basically says the interest will only be deductible in full inn the hands of the unit holder if the unit holder has a right to receive all the income and capital of the trust.

I am not sure what you are saying about you drawing down existing equity for a deposit - who is borrowing here you or a trust and how will those monies be used and by who.

 

[Dingus]

I am not sure what you are saying about you drawing down existing equity for a deposit - who is borrowing here you or a trust and how will those monies be used and by who.

What I mean by borrowing is that I have existing equity in my properties in my own name which I am drawing down for the purpose of buying units in the unit trust (which will house a property and generate income). As I have effectively borrowed again (loan with the bank/drawn upon equity - however you wish to phrase it), I am able to take a tax deduction for the interest in my own name as I am buying for income purposes.

The trust will then have money to put down a deposit on an investment property in which the trust will then also borrow from the bank to fund the rest of it.

 

[Terry_w]

What I mean by borrowing is that I have existing equity in my properties in my own name which I am drawing down for the purpose of buying units in the unit trust (which will house a property and generate income). As I have effectively borrowed again (loan with the bank/drawn upon equity - however you wish to phrase it), I am able to take a tax deduction for the interest in my own name as I am buying for income purposes.

The trust will then have money to put down a deposit on an investment property in which the trust will then also borrow from the bank to fund the rest of it.

ok. but is that trust a fixed trust?