Insights from a Tax Accountant: Deciding on Property Ownership
We received an enquiry from a client not long ago regarding their intention to purchase a residential property and their uncertainty about the most suitable ownership arrangement. When it comes to property ownership, numerous factors come into play, necessitating careful consideration. In the following discussion, we delve into the primary concerns that should be considered before finalising the purchase agreement. A tax accountant can provide valuable insights in this regard!
- Land tax – This is payable on the unimproved land value of the property where the combined value in that person or entity’s name exceeds the land tax-free threshold of $755,000 (for the 31 December 2020 land tax year – this threshold will likely increase for 31 December 2021). The existing properties owned in each person or entity’s name, including part ownership, must be considered as land tax levied on the combined land value of all properties owned in that name.
To help determine what effect this existing property ownership might have on the decision of what name to buy the new properties in, you will need to know the exact unimproved land values of the existing properties and whose name they are in. This would help you to minimise land tax if at all possible. As an aside, Family trusts do not have access to the land tax-free threshold of $755,000, so putting the property in a trust name will not save land tax. To bring this information all together, you must also know the unimproved land value of the properties to be purchased.
- Asset Protection – While trusts are flexible entities, they only provide asset protection where the assets are “settled” on the trust rather than lending to it. If you buy the property in the trust name, with borrowing from the bank, and the rest of the funds come from you personally, this latter amount is a loan to the Trust, which means it will still be shown as an asset of the individuals lending the funds.
If anything went wrong and legal action was taken against the individuals, this asset (i.e. the loan to the Trust by them) would be available to the creditors. So there is no actual asset protection unless they “gift” or “settle” the asset into the trust. There are downsides to this as well as they lose some control over the asset depending on the terms of the deed. Not a decision to take lightly and will need to be discussed to understand the ramifications.
The issue to consider is what risk the individuals have in their own hands. Are the directors of companies? Is there any likely risk that might come from this directorship? Can this risk be adequately covered by Directors’ and Officers’ Insurance? Directors are protected from debts of the company unless they insolvently trade or are fraudulent.
There is another risk from actions on statutory laws like Workcover if they don’t meet the requirements. Realistically though, successful actions against directors are rare, and if Directors’ and Officers’ insurance is in place, there would usually be adequate protection. If the risk is low, you would typically take the cheapest route and just put the properties (subject to any other needs) in personal names.
Other issues to consider when putting property in a trust name is whether the deed is drawn up correctly to avoid the foreign person surcharge for stamp duty and land tax, making both a lot more expensive. If you wanted to put the properties in a trust name, the deed would need to be looked at closely and amended if the wording means the surcharge is applicable.
- Borrowing – Trusts are harder to borrow and more expensive in establishment costs. Personal names are a lot simpler. Also, you would need to determine the level of borrowing to be contemplated as, if the properties were to be negatively geared, then the loss would be caught in the trust’s name and, if there is no other income to use against it, the loss would be locked up in the trust. You would need to know what the property rent would be and what the likely expenses and interest would be. You can then determine whether there is negative gearing and whether it will be usable. Using a Unit Trust instead of a Family trust may help with this problem, but that adds another layer of complexity and cost to the set-up.
- Income in each of the Individual’s names – The other income level in each individual’s hands will also affect what name the properties might be put in. If both are on the same tax rate, then it will not matter. If one of them was to end up on a lower income in the future, then you might consider using a trust to smooth the income of the two of them when on different income levels. This depends on the loss being usable in the trust and having a net income that could be distributed to the lower-income person.
Children are not used until they are over 18 and on adult tax rates. That would have to be considered as the children are beneficially entitled to any income distributed to them. You always have a battle here. If the property is positively geared, you want the income at the lower tax rates. If negatively geared, you want it at the higher tax rates. At the end of the property ownership, you want the capital gain at the lower tax rates. The conflicting income needs versus capital gain can sometimes make deciding what name to put the property in the complex.
- Company name – if the properties to be purchased are to be held as investments, then the adverse CGT ramifications on the sale of ownership in a company name would probably stop you from using this option. When a property is owned in a company name, the capital gain does not get access to the available discount for holding the property for more than 12 months that would be available in an individual or trust name. Also, the negative gearing (if there is any) would be trapped in a company and unusable. One upside with a company is it would possibly lower land tax by giving an extra land tax-free threshold, but this needs to be considered in conjunction with the costs of CGT and the inability to use the negative gearing.
As you can see from the above, deciding what name to put the properties in needs proper consideration. The unimproved land values of the properties already held and to be bought, the terms of the trust deed, the borrowing levels to be used and the possible income levels for the related individuals now and in the future would need to be considered. Simplicity and cost-effectiveness are also essential. The decision on precisely what names the property is put in will depend on clarifying the above points.
If you want to discuss your individual circumstances, please don’t hesitate to contact us.
Author: Michael Goodrick
*Correct as of 26 October 2021
Disclaimer – Kreston Stanley Williamson has produced this article to serve its clients and associates. The information contained in the article is of general comment only and is not intended to be advice on any particular matter. Before acting on any areas in this article, you must seek advice about your circumstances. Liability is limited by a scheme approved under professional standards legislation.