To protect your property investment, it is important to establish an ownership structure that works for you and your fellow investors. From family trusts to limited liability companies, Lodge City Rentals General Manager, David Kneebone, looks at the best structures for rental properties available.
When it comes to structuring rental property ownership in New Zealand, there’s no one-size-fits-all solution.
“The most common ownership structure we see are mum and dad investors, and then their family trusts,” says Jeremy O’Rourke, City Branch Director at Lodge Real Estate.
While many buy investment properties in their own name, it isn't the only option. They can also structure the ownership as a Look Through Company (LTC), Limited Liability Partnership (LLP), Family Trust or Tenants in Common (TIC).
Each has its own benefits and drawbacks, and usage will vary depending on the owner’s circumstances.
Transferring your assets to a family trust means you don't own the assets anymore; the family trust does. This is important to protect your assets. The family trust is a good ownership solution if you are buying positive-geared properties that won’t make a loss or, will make very minimal losses, prior to becoming profitable.
Asset protection: Since you no longer “own” the properties you placed in the trust, the trust can protect these properties from unwanted claims, e.g. claims from former partners. The properties are also protected from creditors to whom you have given personal guarantees.
Wealth preservation: Placing properties in a family trust allows for wealth to be preserved for your family as the trustees will, in theory, act in the best interests of the beneficiaries, i.e. you and your family. This should result in the preservation of asset value for your family in the case of your death.
Improved confidentiality: Once your properties have been placed in a trust, it will be very difficult for others to use ownership records to determine who owns the properties.
Limited distribution: A trust can only distribute profits, not losses, to its beneficiaries. From an investment point of view, not being able to use rental losses from your properties to offset against your taxable income can be a major drawback.
Potential loss of control: Management decisions must have agreement from all trustees. This could result in less control over your investment properties if independent trustees are involved.
Higher marginal tax rate: Trusts are taxed at 33 per cent versus 28 per cent under a company structure such as a LTC.
Tax claims: Many accountants and lawyers recommend LTCs because they allow losses to flow through to the shareholder's individual tax returns. This means, as an owner, you can claim losses from a rental property against the tax you pay on your day job.
In Auckland, it’s nigh impossible to buy a property where the yield is high enough for the owner to make a profit on the rent alone. Though the Hamilton market does have greater opportunity for this, many buyers factor the tax benefits from their rental losses into their overall equation when investing in property.
Ownership flexibility: Ownership of LTCs can be tweaked according to the income and tax rate of the owners. For example, where the property is making a profit, the majority shareholder of the LTC will be a spouse who is in the lowest tax bracket. This is ideal where that person is on the 17.5 per cent tax bracket or lower.
Important! It's a good idea to involve an accountant and lawyer in setting up a LTC so you don't risk being accused of tax avoidance in the future.
Limited liability: With an LTC you have the benefit of limited liability. This is a legal structure that is a separate entity yet still under your control, and is treated like a partnership at tax time: the best of both worlds.
The downside of LTCs is that they are ripe for political tinkering. Labour has recently introduced new ring-fencing rules that prevent owners offsetting the rental losses of their LTC against their individual tax return. In other words, these new changes prevent negative gearing.
An income tax partnership can be used to own a rental investment property. In this scenario, each person is an owner of the property. The partnership return is used to determine the share of profits for each person from the investment property.
As no company has been created, compliance is a little less. However, each owner must file a tax return with the IRD and one for the income tax partnership. Furthermore, the percentage of ownership cannot be changed later, unlike a LTC.
Investors involved in a partnership also need to have clear distinctions between partnership and individual expenses. Unlike a LTC, where company costs are separated and accounted for, partnerships rely on diligent bookkeeping from all parties. If the owners aren’t on top of their paperwork, you can end up with a real mess at financial year end, as well as an auditor’s nightmare.
The ‘tenants in common’ structure of investment property ownership enables shares in the property to be divided unevenly between owners. This approach is often used when owners have contributed different amounts into the property, or for tax reasons.
The other big advantage of TICs is that profits or losses can be split according to the percentage of ownership. These are declared to the IRD via the owner's individual IR3 tax return.
The Tenants in Common ownership structure also allows the joint owners to change ownership shares. For example, if one wants to sell part, or all, of their holding, the ownership percentages can be adjusted accordingly.
Structuring the ownership of your property doesn’t need to be complicated. The important thing is that it works for you. There is also the flexibility to change your investment property ownership structures as your portfolio grows so no one set up needs to be long term.