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Who Will Own Your Next Investment?

Taken from Wakefield Lawyers - wakefieldslaw.com

Purchasing an investment property is an exciting time regardless of if it’s your first or fifth investment. Each purchase is different, and each purchaser has different objectives, but it is imperative that the right decision is made before the purchase is completed to avoid costly restructuring costs and potential tax liabilities down the line. Even the most seasoned of purchasers should give consideration to the ownership structure as there are a lot of different ways to do this: in your own name, in the name of a company, in a trust, in a company owned by a trust or in a partnership.

We set out some of the key pros and cons of buying an investment property in each of these structures to highlight some of the issues that you, as a purchaser, should consider. This is in no way an exhaustive list, and each purchaser’s circumstances and objectives should be carefully considered before a decision is made. Furthermore, it does not deal with the complex issue of GST, and whether it is payable or a deduction available, which is a critical consideration when buying a property.
 

Purchased in your own name

Pros

  • Simple and cost effective.
  • If the property is owned by more than one person, each person can own a % to reflect their respective contributions. This may also drive tax benefits if owners are on different marginal tax rates.

Cons

  • The owners will be personally liable should issues arise such as disputes with tenants or breach of landlord’s obligations and duties.
  • A decision to transfer the property to another entity, such as a company, will trigger the obligation to pay capital gains if the property was purchased within the last 5 years (known as the ‘Bright-Line Test’). This is the position even if the owner is the sole shareholder and director of that company.

 

Purchased in a company

Pros

  • The limited liability status means that shareholders have protection from personal liability.
  • Directors can be indemnified by the company for any personal liability they incur.
  • If the company elects to be a look through company, then losses can flow to the shareholders - meaning they can claim losses from the property against their personal income tax.
  • Shares in the company can be allocated to shareholders on lower marginal tax rates to help drive tax efficiencies.
  • In many instances shares in the company can be transferred or sold to another entity, including a trust, without triggering the Bright-Line Test.

Cons

  • Set up costs - albeit with the Companies Office online services (https://companies-register.companiesoffice.govt.nz/) these are not significant.
  • Company accounts and tax returns will have to be prepared and filed each year creating, additional compliance costs. That said, current innovation in online accounting platforms such as Xero have significantly reduced these costs.
  • The company cannot distribute dividends to any person who is not a shareholder. This limits the ability to allocate profits to non-shareholder family members.

 

Purchased in a trust

  • Pros

    • Income can be distributed to beneficiaries on lower marginal tax rates, but note that distributions to ‘minor’ beneficiaries (i.e. under the age of 16 years of age) are taxed at the trust rate of 33%.
    • The trust doesn’t have to distribute taxable income to be able to provide for the beneficiaries. For example, the trustees can distribute capital or they can provide trust property to a beneficiary for less than market value. In most situations, these ways of providing for beneficiaries are not taxable, unlike the distribution of income.
    • A degree of protection from creditors and relationship property claims, as the property is owned by the trustees on behalf of the trust.

    Cons

    • Set up costs, which are approximately between $2,000-3,000 (although many people already have existing trusts that can be utilised).
    • If the property is rented, then trust accounts and an annual tax return will have to be prepared, creating additional compliance costs.
    • Trust losses cannot flow to the beneficiaries to be offset in their personal tax returns. They can only be carried forward and applied against any future profits of the trust.

     

    Purchase in a company that is owned by a trust

    Pros

    • The limited liability status means that the trustee shareholders are protected from personal liability.
    • Directors can be indemnified by the company for any personal liability they incur.
    • In many instances shares in the company can be transferred or sold to another entity, including a trust, without triggering the Bright-Line Test.
    • If the company declares a profit, the company will pay income tax at the company rate of 28%. The after tax profit can be distributed to any beneficiary at their personal tax rate (unlike a company, where it is only the shareholders). ‘Minor’ beneficiaries will pay an additional 5% as their rate is set at 33%. Other beneficiaries on marginal tax rates less than 28% will not pay additional tax.
    • As above, the trust can distribute trust property to a beneficiary for less than market value and in most situations this is not taxable, unlike the distribution of income.
    • A degree of protection from creditors and relationship property claims, as the shares are owned by the trustees on behalf of the trust.

    Cons

    • Costs to set up and ongoing compliance costs (see above for a company and a trust), but in this instance both the company and trust costs are incurred.

     

    Purchase in a limited liability partnership

    Pros

    • Often an appropriate vehicle for substantial business interests or where significant capital raising may be contemplated.
    • Separate legal entity which limits liability to the individual owners.
    • Profits and losses flow through directly to the owners.

    Cons

    • Costs of formation and on-going management and compliance can be significant.