What’s the Best Ownership Structure for Investment Properties?
Many property investors wonder what ownership structure is best for their investment properties, i.e. whose name should be on the title.
The ownership structure you choose will depend on your financial circumstances and financial goals for the investment property. There are a few key considerations you need to factor in your decision too, including:
- asset protection,
- tax implications, and
- costs and complexity of the ownership structure.
Different ownership structures have different benefits, and it’s important to understand the pros and cons of each one before deciding which one is right for you.
So, in this article will discuss the most popular ownership structures that many Australian property investors use.
Key Factors You Should Consider Before Choosing an Ownership Structure
Before delving into the different types of ownership structures in Australia, there are a few considerations you need to take into account before making your decision.
Ultimately, the decision will come down to your financial circumstances, risk appetite, and your property portfolio’s objectives. So, you need to consider:
Creating an asset protection plan to minimise your risk is an important step in building your asset portfolio.
If you’ve created your wealth through an asset portfolio under your personal name, you’re especially vulnerable to losing your assets if you’re a business owner.
Asset protection is a means of shielding your personal assets from being used to meet a business creditor’s claim.
However, there are many issues to consider when it comes to establishing a viable asset protection strategy. Beyond that, there are strict rules and timelines to ensure that your strategy is not part of a greater objective to defeat creditors’ interests.
There are various tax benefits associated with different structures. So, if you want to manage your investment property tax implications effectively, you’ll need to consider an ownership structure favouring your tax circumstances.
For example, you’re only required to pay 15% income tax on the rental income if you purchase your investment property using a Self-Managed Superannuation Fund (SMSF). So, if you personally fall into a higher income tax bracket and more than 15% income tax, this may be a smart tax strategy (after considering all the other implications and regulations of SMSF).
Cost and Complexity
Owning property in an SMSF requires you to adhere to far more regulations and audit requirements – so it could end up being a costly and complex exercise.
For example, investing in your personal name may be the most simple and cost-effective ownership structure if you’re a low-risk individual.
What Investment Property Ownership Structures Exist?
Now that you have an idea of what you should consider before choosing an ownership structure, here are a few ownership structures widely used by Australian property investors.
Individual Ownership Structure
Individual ownership is the simplest ownership structure to understand, as it means that an individual owns property in their personal name alone.
In terms of the tax benefits, the Australian Tax Office (ATO) allows you to claim various rental income tax deductions such as interest on your loan, rental expenses and depreciation.
And if your investment strategy accommodates negative gearing (i.e. it’s running at a loss), you’re eligible to deduct that loss from other taxable income.
Unfortunately, however, individual ownership offers limited asset protection. Your options are also quite limited in tax planning because you can’t distribute any of your income or expenses to anyone else.
So, the trade-off between limited asset protection and increased tax benefits is one of the factors that should be considered when opting for an individual ownership structure.
Using a trust ownership structure has become an increasingly popular consideration for many property investors because it can offer excellent tax benefits and asset protection.
The most common trust ownership structure is a family (or discretionary) trust.
Property investors use their family trust as an asset protection strategy because it creates a separation between the owner and those who will benefit. So, the beneficiaries have no right to any of the property within the trust and any assets held in the trust are held in the trustee’s name.
From a tax planning perspective, discretionary trusts allow the trustee to divide the income between the beneficiaries in the most tax-effective way each financial year.
For example, for beneficiaries of the family trust who fall under a lower marginal tax rate, the trustee can distribute more income to them to reduce the overall tax paid by the family group.
However, you can’t subtract negative gearing losses from your taxable income as losses are quarantined in the trust. Thus, setting up and managing a family trust can be a complex exercise.
So, you’ll also have to consider whether the benefits exceed the costs of setting up and maintaining a family trust. That’s where we come in – to help our clients navigate the process.
Joint Property Ownership
Joint property ownership is common in Australia, where more than one person shares in purchasing the property. For example, you and a spouse own property together.
There are two primary forms under the joint-property ownership structure:
- According to their legal agreement, tenants in common share interest in the property – it doesn’t have to be equal shares – and their interest gets distributed according to their will.
- Joint tenants share an equal interest in the property, and the surviving joint tenant assumes a full interest in the property should the other co-owner pass away.
How you structure your joint property agreement can have significant impacts on your tax obligations and asset distribution.
To learn more about the tax benefits and implications associated with a joint property ownership structure, make sure to check out our guide to joint property ownership in Australia.
From an asset protection perspective, joint property ownership offers limited asset protection, similar to individual ownership. However, there are ways to structure your joint property agreement in a manner that allows for more asset protection.
For example, under a tenancy in common agreement, you could put 1% of the asset in your name and 99% of the asset in the name of your non-at-risk spouse. But you’ll need to consult a property investment expert or legal expert on the best way to navigate this agreement for asset protection.
Purchasing Investment Property With an SMSF
One of the most common reasons property investors choose to purchase property within an SMSF is to manage their investments and because there are several tax benefits available.
For example, an SMSF must pay 15% income tax on the net rental income generated by the investment property. So, if you personally fall into a higher marginal income tax bracket that is more than 15%, then using an SMSF as a property ownership structure could make sense from a long term tax perspective.
And once you retire or reach the pension stage and can access your retirement saving, future income from the property investment will be tax-free.
Lastly, investment properties held in your superannuation fund for longer than 12 months qualify for a capital gains tax (CGT) discount on SMSF property sales, and your capital gains tax liability will average down to about 10%.
Generally, property investment held within an SMSF will be protected from creditors in the event of insolvency. So, as with a trust, SMSFs offer a good asset protection strategy.
What’s more, if the SMSF defaults on the loan repayments, the lender only has access to that particular property and nothing else held by the SMSF because of the limited recourse borrowing arrangement (LRBA).
Unfortunately, however, there are strict superannuation rule guidelines. So, managing an investment property held in an SMSF can be a complex and costly exercise.
Beyond that, you can only access the funds in the SMSF when you retire or meet a condition of release.
Having a company own your investment property means that any passive or rental income derived from that property will only be taxed at the company tax rate of 30%. So if you’re an individual that falls in a high-income tax bracket, a company ownership structure could be a great tax effective strategy.
However, you won’t have access to the capital gains tax (CGT) 50% discount on the eventual sale of your property.
A company structure is a separate legal entity. This means that your assets would be protected from your personal liability. However, it won’t be protected from the company’s liability. Where the company’s shares are owned in the individual name, it is effectively exposed to third party creditors.
Unfortunately, similar to managing an SMSF, there are quite a few legal considerations for setting up and maintaining a company. It can also be quite costly to maintain.
Australia has several investment property ownership structures that you may want to consider when purchasing your next investment.
You can either take the simple route and own the property personally, or you can consider looking into:
- family trusts,
- SMSFs, and
- joint ownership arrangements.
Each ownership structure comes with its own advantages and disadvantages. Hence, it’s important to weigh up the costs and complexity of each structure against what is most important in terms of asset protection and tax implications before deciding which one best suits you.
To determine whether a family trust is a suitable option for you, it’s ideal to consult with a tax specialist or financial advisor for advice.
At Property Tax Specialists, our main focus is helping property investors maximise their opportunities and protection while legally minimising their tax liabilities.
We’ll get to know you and develop strategies that consider all aspects of your business, investments, income, family, and lifestyle goals. Our emphasis is on protecting assets and taking advantage of all opportunities to minimise tax within legal constraints.
To discuss any matter relating to ownership structures, protecting your assets or arranging your affairs for minimum tax, get in touch today.
Please note that every effort has been made to ensure that the information provided in this guide is accurate at time of writing. You should note, however, that the information is intended as a general guide only, providing an overview of general information available to property buyers and investors. This is not intended to be an exhaustive source of information and should not be seen to constitute legal, tax or investment advice. You should, where necessary, seek your own advice for any legal, tax or investment issues raised in your affairs.