What’s the best ownership structure when buying a house?
The most popular way to buy a property in Australia is in your own name. In fact, more than 65 per cent of homebuyers use this very method.
Buying a property in your own name is quick, easy and uncomplicated but in doing so, you could be missing out on a range of other benefits and protections that alternative ownership structures can afford you.
With a range of ownership structures available to home buyers and investors, your first port of call is always your accountant.
Australasian Taxation Services Sydney director Simon Gold said there were a few rules of thumb to follow when considering the right structure to purchase a property.
“There’s absolutely no one size fits all approach," Mr Gold said.
"Commonly as an accountant what I’d be recommending is your main residence is owned personally, your investment properties are held within a discretionary trust, and if you’re undertaking a development, you’d do that in a company structure with the family discretionary trust being the shareholder."
While most people are familiar with buying a property in their own name, there are still some clear advantages to using this approach.
“The simplest, cheapest, most common way of property ownership is to own the asset as the individual," Mr Gold said.
"If the property was the main residence, in other words the family home, then it is beneficial from a tax perspective owing to the capital gains tax exemption.”
“It is the most simplistic way of obtaining finance too, because the individual’s personal income is taken into account and most of that can be proven by way of tax returns, payslips, etcetera.”
Mr Gold suggested that buying property in your own name was also beneficial when considering the tax implications and income.
“When the property is going to be an investment and you’re buying it as an individual, or more importantly multiple individuals, say between a husband and a wife, you can skew the ownership ratio towards the taxpayer that will obtain the most benefit,” he said.
“So negative gearing losses are preferred when you have a higher income-earning individual because the tax breaks provided are reflected with the higher marginal tax rate.”
Despite its ease, Mr Gold said there were some limitations to buying a property in your own name.
“The main disadvantages would be asset protection in that you own the asset and therefore if you are personally sued, the property is owned directly and therefore is more at risk,” he said.
“Another disadvantage on the tax side is it’s all well and good to buy property in your individual name or as multiple individuals to get the tax advantage, but what happens if that property starts off negative and then becomes positively geared?”
Mr Gold said that for developers, using a company structure could be very beneficial.
“A company is a separate legal entity that is controlled or run by the directors but owned by the shareholders, and thus can create separation of ownership and control. The property asset would be in the name of the company as would the mortgage,” he said.
“Any income that is derived is taxed at the corporate rate, which is currently 30 per cent. Although there are two tiers of tax rates, being 27.5 per cent for a small company and 30 per cent for a larger company.”
However, if you’re not looking to hold a property for the long-term, Mr Gold said this might not be the best structure to consider.
“The main disadvantage is no capital gains tax discount," he said. "Banks will typically lend a lower amount too meaning the ability to borrow is less.
"There is, however, enhanced asset protection because a company is a separate legal entity, but the rule of thumb is you don’t buy appreciating assets in a company.”
“Commonly what we would see is if it was a property development where the underlying properties are on a trading account, i.e. property bought to be redeveloped and then sold, then a company structure does make more financial sense because a trading business doesn’t get the 50 per cent capital gains discount anyway.”
There are a range of trusts available for purchasing assets, which Mr Gold said were becoming more popular with investors.
“A trust is not a separate legal entity, it’s a relationship between the trustees that control the asset and the beneficiary or unit holders that have an underlying interest within the trust," he said.
"The two most common forms of trust would be a family or discretionary trust (the term’s interchangeable), or a unit trust.
“A unit trust is not too dissimilar to a company in the sense that you have defined unit entitlement so you have a fixed interest within the trust. Any profits that are derived flow in accordance with that ownership ratio.”
Mr Gold said unit trusts were common, where there are unrelated business partners and the unit trust would then buy the property and the unit holders would then acquire a stake within that property.
“Commonly the unit trust itself will obtain finance to buy the underlying asset, not necessarily at the unit holder level, although sometimes that can happen as well and any interest deduction is claimed against the unit trust income of that recipient," he said.
"Unit trusts are quite good for holding assets between unrelated parties, such as business partners.
“A discretionary trust on the other hand, there are no defined owners and the trust can therefore allocate whatever income there is in a very flexible manner.
"While the unit trust has defined unit holders, i.e. defined owners, a discretionary trust or a family trust doesn’t.
"So the single biggest advantage to the family trust is flexibility. With a family trust there are also significant asset protection benefits.”
When looking at trust structures, Mr Gold said it was important to balance tax implications with complexity for finance reasons.
“In terms of financing, commonly the trustee will obtain the loan and the trustee of both the family trust or a unit trust can either be a company or individuals," he said.
“Generally speaking the more complicated the structure, the more difficult it is for obtaining finance so that’s something to bear in mind as well.
“The cleaner the structure, the easier it is, but the more complicated, yes you might get tax benefits, but it often comes with not being able to borrow as much, meaning you may need a larger deposit."
Mr Gold said joint venture structures were often best when there was an end-date in mind with the investment.
“With a joint venture, it’s more common with a development than it is with a passive investment because in a joint venture you share the proceeds, not the profit," he said. "With a joint venture, it’s multiple parties each bringing something to the table and then the end product, that is the end properties, are allocated.
“Maybe Developer A owns a parcel of land and Developer B owns the parcel next door so you come together with the goal of building something on both parcels of land. Not so common on the passive investment side.”
Consider Interest Rates
In the current low interest rate environment, Mr Gold said he had started to see a move towards family trusts.
“We have noticed a huge increase in the use of family trusts though, I will say, brought about by low interest rates," he said.
"Negative gearing is nowhere near as prevalent as what it was a decade ago because interest rates are so low.”
“So when people are taking a longer term horizon, the family trust option, purely if it’s just investment property that is, becomes much more advantageous because the negative gearing losses that the individual used to receive, or the individuals if they were buying it in partnership, aren’t there to the same extent.”
"The bottom line is every entity has its advantages and disadvantages, whether it be ease of buying, lower transaction costs, ability to get finance or tax benefits.
"And, of course obtaining professional advice to ensure you are maximizing those benefits and to ensure the right ownership structure is in place from the beginning."