COMMENT: The importance of correct structuring
Structuring the ownership of a property portfolio is rarely the first – or even the second - thought for new investors. But it should be, argues property accountant Anthony Appleton-Tattersall*.
Thursday, November 5th 2020, 11:16AM
Anthony Appleton-Tattersall
Even those who do consider it often feel like they can deal with it later. Historically, they could – but it’s much harder now.
Once, you could start buying properties in your own name and, then, in three or four years (when you decided your portfolio is big enough) engage an accountant. They could fix it all up for you.
Maybe a few thousand in legal fees, but not the end of the world. Then the Bright Line test changed all that.
No exemption for related-party transfers means restructuring to a company or trust can create big tax costs, and resets the timer for another five years.
As a result, such transfers can result in tax bills of $100k+. Naturally, the restructure doesn’t happen and you miss out on all the benefits – in some cases thousands of dollars a year.
This is not the article for all the pros and cons of various structures. Go Google that. Or comment below and I’ll consider it for a future writing.
Instead, I’m going to look at the rise of the standard company as a property investment vehicle – in some circumstances.
For years the “go-to” investment structure has been the Look-Through Company (LTC). Not the best choice for everyone, but it offers benefits to the majority of investors, at a fairly low cost.
LTCs were preferred over regular companies for two primary reasons:
1) Losses pass through to the shareholders. In an ordinary company they remain stuck until offset by future profits
2) It’s easier to withdraw capital gains. Ordinary companies only allow this tax-free when winding up the company, which can have other costs.
Ringfencing (since 2019) means reason one is now irrelevant. Losses are stuck regardless of structure. And lending rates near 2% mean fewer losses anyway.
Reason two remains valid, and is a huge problem for some investors who should not consider this structure. But it’s not the case for everyone!
A significant subset of the investing community plan to never sell their properties, or if they do, to reinvest proceeds into another. They don’t want to spend their capital gain for decades – if ever.
Those investors might consider a standard company. There are several benefits over an LTC:
• Fixed tax rate at 28%: Instead of income flowing to shareholders paying 33% (or Labour’s expected 39% on $180k+), it is held in the company and taxed at a flat comparatively low rate.
While it’s true this is only interim tax (the owner’s individual rate must eventually be paid on dividends) this segues to the next benefit…
• The ability to defer final tax into future years: No need to declare a dividend when income is high; it can be held for the future if income is expected to be lower – parental leave, career break, or retirement being common reasons.
• Change shareholding without impacting bright line.
Structuring is set up with the information currently at hand. Good accountants try to build in flexibility for change, but can’t predict the future. Sometimes adjustments are needed.
LTC shareholding changes result in a “deemed disposal” of the assets of the company at their market value – because IRD “looks through” to the underlying owners.
For a normal business in an LTC, this creates worry of depreciation recovery. But residential investors have it worse – Bright Line triggers for the sold portion of any property owned. And a new five-year test starts.
Ordinary companies avoid this problem. Even when shareholding changes, property owner isn’t seen to.
Don’t go trying to avoid Bright Line using a company – there are explicit anti-avoidance provisions for this. But for a simple change in shareholding where getting around Bright Line isn’t the intention, a regular company wins out over an LTC by a mile.
For the right kind of investor, an ordinary company could be exactly what’s needed. Not for everyone, but can be worth considering.
*Anthony Appleton-Tattersall operates AAT Accounting Services.
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