Ownership structures explained
Depending on the entity in which you choose to buy your property, there can be legal and tax implications. Should you buy in a company name, in a trust, as an individual, joint venture or partnership?
According to Jessica Darnbrough, spokesperson for Mortgage Choice, recent data shows buying with a partner or spouse is the most popular way to buy an investment property.
"More than 65 per cent say they had bought their first investment property in this way. But, just because buying property with a partner or spouse is proving very popular amongst investors, doesn't mean to say that this is the only way to buy a property," she says.
Many investors decide to buy or refinance their property in the name of a Pty Ltd company for a variety of asset protection and taxation reasons, says Darnbrough.
"When you borrow in the name of a company, the company will then own the investment property, the company will be the borrower and all directors of the company will be required to guarantee the loan," she explains.
"Similar to buying in a trust, there are a variety of pros and cons associated with buying property through a company.
"One of the pros associated with buying properties in this way is that the tax rate internally in the company is capped at 30 per cent.
"Furthermore, because the directorship of the company can leave out the spouse, the family home can be owned outside of the realm of possible litigants.
"But just as there are pros associated with buying property through a company, there are some cons, most notably: banking restrictions.
"Not every bank is set up to lend to company structures. It is quite common for banks to make simple mistakes such as requesting tax returns for a shelf company that has just been set up.
"In addition to this, many professional package discounts come with additional bank products such as bank accounts and credit cards. In many cases these do not work in a company name. For these reasons, it is critical to apply with the right lender."
Julia Hartman, registered tax agent, chartered professional accountant and founder of BAN TACS Accountants says she would not normally recommend people buy in a company name.
"Never buy under a company as they don't get the 50 per cent capital gains tax discount," she warns.
Quan Dang, director of Ally Financial Group, says trusts are a suitable entity in which to buy, however there are different types of trusts such as a discretionary trust or a unit trust.
"A hybrid trust was created by lawyers and accountants to add an additional layer of protection," he says.
"If you want to get funding (and at a reasonable price) don't go down this path.A hybrid trust convolutes the ownership of an asset making it difficult for a lender to potentially exercise its right of re-possession in the event of a default, so consequently most lenders won't touch these.
"There are few exceptions to this rule but usually when they are able to lend, there are further restrictions such as loan-to-value ratios."
Hartman says fixed or unit trusts have no flexibility and are only useful for asset protection from tenants but are not useful to protect the property from personal creditors.
"They are also useful for avoiding stamp duty if you want to transfer around ownership of the units, but in most cases not worth the costs.
"A discretionary trust has flexibility of profit distribution and good asset protection from the tenant and protects the property from your personal creditors. But losses are stuck in the trust until offset by profits, so this is not good if the property is negatively geared, unless you have another trust that can distribute profits to this one," Hartman says.
Darnbrough says trusts are becoming an increasingly popular choice for many investors, thanks to their flexibility.
"Typically, trusts come in a few different forms including unit trusts, family discretionary trusts and hybrid trusts," she says.
"Generally speaking, there are some significant advantages and disadvantages associated with buying in a trust.
"One advantage of buying through a trust is that it provides the borrower with a certain level of asset protection. Should any beneficiary become bankrupt or financially troubled, any assets that are owned by the trust cannot be touched by the creditors.
"In addition, as long as the asset has been held for more than 12 months, most trust structures, including unit trusts, are eligible for a 50 per cent CGT discount on all capital gains that are produced.
"Further, a unit trust is cheaper to establish and maintain than a company. It is also generally an easier procedure to wind up a trust than to wind up a company.
"Finally, there are fewer regulations governing trusts than companies, and units can generally be easily transferred and re-acquired without any legal problems."
Darnbrough says while the advantages of buying in a trust are many and varied, there are some notable disadvantages associated with buying property in this way.
"Firstly, the act of transferring a property that is owned by an individual into a trust will see the trust liable to pay stamp duty on acquisition of the asset. Additionally, the individual who is transferring ownership to the trust will be liable to pay capital gains tax on the disposal of the asset," she says.
"Secondly, for investment properties that are owned by trusts, it is not possible to offset any rental loss amounts against other investment income. The loss must remain quarantined in the trust until such time that a rental gain is made and the previous loss can be offset against it."
Purchasing property as an individual or with a partner or spouse is the most common form of property investment.
"As a general rule of thumb, when you buy with a partner or spouse, both of your names will go on the home loan," Darnbrough says.
"Buying with a partner or as an individual is usually quite a simple process. Furthermore, because no companies or trusts are involved, setting up an investment loan structure is a fairly cost-effective procedure.
"Depending on the way the property is geared, there are significant tax incentives associated with buying investment properties as an individual or with a partner/spouse.
"The downside of buying alone or with a partner/spouse is that you have little to no asset protection. Anyone who is suing you, from a tenant injured in your property to a business associate, can attack the assets you hold in your name or your share of whatever is held in joint names."
Dang says buying as an individual is acceptable for a small developer or mum and dad doing a small project but not ideal from an asset protection point of view.
Hartman says sole ownership in a high-income earner's name is best for negatively geared properties that are not going to be sold until a person retires.
A Joint Venture
Buying property through a joint venture can help Australians achieve their dream of home ownership faster, according to Darnbrough.
"Property joint ventures or co-ownership makes owning a property more affordable as it enables potential buyers to pool their money together for a deposit. They also utilise their shared borrowing power to obtain a loan and effectively share their mortgage risk," she says.
"In a joint venture arrangement, the cost of the property and all of the associated expenses are generally split between the co-owners, although the nuts and bolts can vary depending on the circumstances.
"For instance, if one of the co-owners has a high income but no savings, they might agree to pay the ongoing monthly costs of maintaining the property, so long as their partner agrees to front the deposit.
"Just like anything however, there are some cons associated with buying property in this way. Firstly, buying property as part of a joint venture can be very risky, especially if there is no formal co-ownership agreement in place.
"For example, if one of the parties is unable to meet their mortgage repayments and no agreement is in place, things can get messy. As such, it always pays to seek legal advice before purchasing property in a joint venture arrangement."
Dang says a joint venture can be problematic and depends on the proposal, size and structure of the entity.
"This may or may not be ideal as potentially there could be other hurdles created by agreements between the parties," he says.
Hartman says a JV is when two parties come together to create something but rather than walk away with profit they walk away with a share of the produce and is therefore not relevant for property investing but may be suitable for developing.
Hartman warns that partners are joint and severally liable for the debt, so should only be done with family members.
"It is best to go with the spouse that is in the most suitable tax bracket," she says.
Dang agrees a partnership may be suited to a spousal arrangement or small development project.
However he says while these structures are acceptable from a lender's perspective it is important for buyers to research the individual merits based on their own circumstances.
"There are costs, taxation, capital gains and other issues to consider so I would always suggest that clients seek advice from their solicitor, accountant and finance broker or lender conjunctively before making a decision," Dang warns.
"Each of these professionals will give advice from very different perspectives. A solicitor will consider asset protection, an accountant will consider taxation advantages and possibly asset protection, a broker and lender will consider ease of transaction and cost minimization.
"When all three of these professionals work together, generally we'll end up with a far better outcome for the client."
Hartman suggests in addition to the entities outlined above, buyers also consider self managed super funds (SMSF) in which to buy property.
"A SMSF has the best asset protection as it effectively allows negative gearing and is even better because of the low SMSF tax rate when people sell."
However, she warns of leverage and liquidity problems and the cost associated with running the fund.
"As a general rule first look at whether SMSF is possible. If not, do the numbers. If your property is positively geared go for discretionary trusts. If negatively geared long term, go for sole ownership in the high-income earner's name.
"There are always special considerations so get professional advice," she warns.