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3 tips to a top property investment structure

In a previous post, we looked at the considerations first-timers and seasoned property investors need to work through in order to optimise their portfolio purchasing structure and power. Essentially, how do you minimise risk whilst maximising return?

The fact is every property investor might well have a number of different structuring opportunities that can be used to their advantage.

However in most cases, you need to know about them before setting up your initial arrangement.

While you may not find immediate benefit in some functions of a particular structure immediately, it will generally have to be in place from the date of purchase in order to optimise your portfolio’s long-term viability.

That’s why you must consider what is best for you over the ownership period from the outset of your acquisition (as opposed to being short-term focused like many people and only thinking about the next three to five years).

So here are 3 tips to help you through the ownership structure maze:

1. Consider a Super Fund

It can take 15 to 20 years (or more) for a property portfolio to produce enough cash flow, over and above expenses, to fund a retirement lifestyle (assuming debt is maintained on an interest-only basis).

A strategy you can adopt to accelerate a property portfolio’s free cash flow is to sell one property on retirement and use the proceeds to repay the portfolio’s debt.

Buying a property in a SMSF with the intention of selling on retirement is one potential strategy, as CGT will be zero and this will leave more money to extinguish most (if not all) debt.

If you choose to implement this strategy when buying a property investment though, it’s important that you’re mindful of your intention to sell within a relatively short period.

For example, buying a property that you can renovate and improve to ‘create’ equity may be an appropriate strategy for this purchase. You should recognise that this strategy carries regulatory risk, in that the government might change retirement benefit taxes one day.

However, it’s likely that super will always be concessionally taxed (the rate just might not be zero that’s all).

2. It pays to use discretion

A good way of capping your tax rate at 30% is to establish a discretionary trust with an ‘investment company’ as the primary beneficiary. The trust will also own the shares in the investment company.

The investment company is just a proprietary limited shell company. The benefit of this structure is that once each individual has exhausted their 30% or lower individual tax rates (i.e. each individual has a taxable income of not more than $80,000 each), the trust can distribute any remaining profit into the investment company, which will pay tax at the company rate (30%).

In the future, the investment company can then pay a dividend to shareholders (i.e. the trust) and the trust has the discretion to distribute the dividend to another beneficiary (while still preserving imputation credits).

This essentially allows you to ‘park’ profit in a company, pay a 30% tax rate and then eventually (possibly) distribute that profit to a beneficiary that has a low tax rate (and maybe get a tax refund via imputation credits).

It allows you to spread your profit over a number of years to ultimately minimise tax.

3. Do we have something in common?

Owning a property as tenants in common can provide some flexibility, in that you can potentially allocate all the cash deposit to the lowest income earner and gear the highest income earner’s share at 100% (plus costs).

For example, if you and your spouse have $200,000 as a deposit and would like to buy an investment property for $500,000, you could consider the following structure:

  • The highest income earner would own 62% of the property and the lowest income earner would own 38%.
  • The total cost of the purchase would be $525,000 – 62% of this total cost is $325,000.
  • Therefore, you would establish one loan account in the highest income earner’s name for $325,000.
  • As we can borrow 80% of a property’s value (or $400,000 in this example), we can establish a second loan for $75,000 in the lowest income earner’s name.
  • 5. However, we have borrowed more than we need so the couple will have $75,000 cash left over (loan of $325,000 plus loan of $75,000 plus cash of $200,000 gives them $600,000 in total, but the total cost for purchase is $525,000).
  • Therefore, the lowest income earner deposits the $75,000 surplus cash in an offset linked to their $75,000 loan.

With this structure, the highest income earner’s investment is geared at 105% (loan for $325,000), whereas the lowest income earner has zero gearing for all intents and purposes (as its loan is fully offset).

Having the lowest income earner owning as much of the property as possible, while not forgoing any taxation benefits (to the highest income earner), provides a good outcome, because when the property produces a taxable profit (maybe in seven to 10 years), as much of that profit as possible will go to the lowest income earner.

At this time, the lowest income earner can withdraw the $75,000 from the offset, claim a deduction for interest charged on the loan and use the cash elsewhere.

This structure will maximise tax benefits when the property produces a loss (i.e. negatively geared) and minimise tax when the property produces a taxable profit.

Stay on the right side of the tax man!

It’s essential to remember that the dominant reason for developing any ownership structure cannot and should not be to ‘obtain tax benefits’, as this may contravene anti tax avoidance provisions.

In other words, the tax office will not look upon your activities very favourably at all!

You must have viable reasons, other than tax benefits, to justify structuring your investments in a certain way.

Notwithstanding this, structuring investments solely around tax consequences is foolhardy, as you must consider other financial planning issues.

For example, the reason for the structure mentioned above could be that the lowest income earner wants the lowest gearing level (because of their lesser capacity to service debt).

In this instance, the dominant reason for this particular structure was to manage risks. You (or your advisers) should document the reasons for any recommendations to ensure no anti tax avoidance provisions are contravened (and you don’t end up in jail!).

Portfolio structuring is one of the areas we specialise in here at Property Tycoon Finance.

So if you would like more information on how you can profit from investing in Australia’s residential real estate sector by establishing clear investment strategies and structures, contact us or subscribe to receive regular post updates and industry insights.

Stuart Wemyss is a chartered accountant and founder of Property Tycoon Finance. Email: wealth@propertytycoonfinance.com.au