In this week’s episode, we’ve got Jayden Vecchio and Louis Strange helping us crack the code of structures. Structures are the ‘building blocks’ you buy property in. Instead of buying your property in your personal name, you might buy it in a trust, a company or superannuation.
We’ll be running through the considerations, the major things you need to look at when deciding where to buy a property and how to structure it. We’ll also be looking at asset protection, taxation strategies, exit strategies and the cost and complexity of it all.
In this episode we cover:
- Why buy property/investments in different ownership structures?
- What are the different types, including companies, trust, super and individuals
- What are the pros and cons of each structure?
- Practical examples of each
Disclaimer: The following information is general only, please don’t take this information as personal advice. Each case is treated differently depending on your personal situation. Please contact Jayden Vecchio for mortgage questions or Louis Strange for financial advice so that your personal situation can be put into context.
The important aspects you need to think about before we go into structures are:
Why do you have structures?
Structures are important for asset protection. When deciding on a which structure is best for you, the major considerations are:
- Are you going to get sued?
- What’s the likelihood of you going bankrupt?
Taxation ie. Individual or Superannuation
This one has a few different levels. It can be set up individually, inside a company or in superannuation. Each structure pays different levels of tax. Individually, you would pay at your marginal tax rate.
Through superannuation, if it were inside accumulation phase, it will be capped at 15%. Determining which level is best will depend on how much income you earn. It also comes down to exit strategy and goals, which we will go through in the pros and cons of each structure.
Cost and complexity of the structure
The more complex the structure, the more it will cost. If you have companies as the trustees or a company within another company, it’s going to be more costly to run.
You also have to look at how many people will be purchasing it and what their relationship is. Different types of relationships (i.e. spouse or business) will require different structure in order for protection.
Please remember, the below examples do not take into consideration your personal circumstances. Please seek advice from a professional if you’d like to be individually assessed.
A company structure is considered a structure that is stand alone operating under PTY LTD (proprietary limited). The more complex the structure, the more it will cost. Look at how many people are going to be a part of purchasing it and what their relationship is. There are different structures you want to account for, for extra protection.
- Good for protection as no one can get inside the company unless you go bankrupt.
- If you’re sued, no one can access your company.
- Capped tax rates. Right now there is a lot of legislation about reducing company tax rates.
- It’s expensive.
- You need to pay ASIC’s fees each year to have the company registered.
- You need to pay accounting fees.
- A company can set you back a few thousand dollars each year. It costs more to set up a company than to just buy a property.
- You don’t get the capital gains discounts. You could own a property for 20+ years and it could go up, but you’ll still have to pay tax on it.
- Getting money out of the company – it’s very difficult to avoid tax here. You still have to pay yourself a full franked dividend so if you’re in the higher marginal tax rate it won’t be a good thing.
- High deposit – No lenders mortgage insurance, you need a minimum of 10% deposit and you won’t get stamp duty discounts.
Trusts – Family trusts and fixed unit trusts
Both family and fixed unit trusts have similar pros and cons.
- Trusts are great from a taxation and distribution point of view. For example, if your property earns $20k worth of (positively geared) income, the income can be distributed to whoever is at the lowest marginal tax rate and pay almost no tax. This can be changed every year, it’s not fixed and is easily changed depending on individual circumstances.
- Trusts get a capital gains discount and can claim 50% reduction on capital gains tax payable.
- Similar to a company with great asset protection, especially if you have a company as the trustee of the trust, rather than a husband and wife.
- It’s hard to get into the trust structure if you’re being sued or litigated against.
- It’s flexible – gives you more flexibility with stamp duty.
- Any losses you make are stuck in the trust. For example, if the property is negatively geared and there’s a $10k loss with no other assets in the trust, there’s no income to offset so you simply lose that $10k.
- If you owned it personally you could claim that loss, but if it’s owned by the trust only the trust can claim that as a deduction and if there’s no other income inside the trust, that’s a loss of the deduction. However if the trust has other assets and assessable incomes it can offset, then it’s fine.
- Additional costs – lodge an additional tax return.
- It’s expensive to set up.
If you’re looking to supplement your cash flow, super is the worst one, because you can’t get your hands on it until you can access your super. In this case, buying it individually might be better.
- Asset protection. This one is the most secure structures, you can’t even get your own money!
- It’s great from a taxation point of view, it has a very low tax rate. Initially, in the accumulation phase, tax is capped at 15%. It then goes down to 10% if it has been owned for longer than a year.
- Inside pension phase – once you hit your preservation phase, around the age of 60, then that property is no longer taxable.
- If it’s negatively geared, there’s nothing to claim a deduction against. For every $1 paid in expenses and interest, you’re only getting 15% back.
- You can’t touch it until you retire or are above your preservation age. It might not be the best strategy if you’re looking at buying a portfolio of property to supplement your income.
- You need to have a 20-30% deposit.
- Getting the property in super. If you own an investment property and want to transfer it to your super down the track, it’s quite hard to do. There are a lot of considerations that the governing body of super take into account. Its sole purpose is for retirement.
- If it’s negatively geared, you’ve got to set up a separate entity (SMSF). If it’s inside that structure, you can’t make any improvements on the property (renovate etc.) However, if your super owns it outright you can.
Individual Structure – the default position
- It’s super cheap! Anyone can go and buy a property without setting up structures.
- Similar to trusts, you get the capital gains discount. It’s good on a deductibility point of view if you’re on a high marginal tax rate (39 – 49% tax rate). If you’re on a low marginal tax rate, it’s a bit pointless.
- It’s simple. Anyone can go out and buy a property in their own name – you don’t have to worry about the complexities that come with trusts or companies.
- No asset protection. If you get sued, there goes your investment property.
- If a husband and wife buy the property 50 – 50 and one no longer is earning an income, half of the deductibility is now gone if it’s in joint names. It’s better for the individual to have all of the deductibility into just one name.
You’ve got to have a plan and look ahead. Practically, why do people buy it in a trust?
Example 1: The hardworking employee
I’m a bus driver on $80k salary, PAYG and it’s just me.
The individual structure would be best on this occasion. If you’re setting up a trust just for this, it’s not worth it as there are no other assets.
Example 2: The entrepreneur
I’m a director and I run a business.
On this occasion, that’s when you want a level of asset protection because you have a higher risk of getting sued.
Summary of options:
- For companies overall, unless your whole business is property, you don’t really want to be buying properties in companies. It’s expensive and you don’t get the capital gains discount.
- If you want access to your property, super is not the way and it is also very heavily determined by your age.
You need to take a step back and think about the options, from asset protection to taxation. Look at your 5 – 10-year plan and understand – will there be maternity leave on the cards? It is important to consider your exit strategy too and getting money out.
For example, if you have $1M property and it’s wrapped up inside super and you’re starting a company and need the money, it will be a really long process.
- Do you want to have an accountant and prepare a personal, company and trust tax return?
- If there are two business owners and they want to buy their own personal property, that would be considered business real property, which could be done on super. This would be a good situation for those individuals.
Remember: This is only general advice and not specific to your person circumstances. Please speak to Louis Strange, a financial advisor to get your personal circumstances assessed.
The Rentvesting Podcast, available on iTunes, was created by Red & Co’s Jayden Vecchio and expert financial planner Louis Strange. Together, Jayden and Louis unpack the facts behind the property market, explain what’s really going on & where the market is heading. They believe in challenging the status quo and want to get out there to educate absolutely anyone looking to enter the property market.