COUNT ON IT

With Gavin Goodjohn

Staples Rodway

OWNERSHIP STRUCTURES FOR RESIDENTIAL RENTAL INVESTMENTS

If you have made the decision to purchase a residential rental property and become a rental property investor, or are currently thinking about doing so, there are a number of things you should consider.

When we talk of Property Investment, we are talking about the purchase of property with the primary purpose of this purchase being the generation of rental income. This is opposed to the purchase of property with the primary purpose being capital gains - which is property speculation. Property investors are taxed on the net rental income generated while property speculators are taxed on the net rental income generated along with the capital gains realised when the property is re-sold. Here we are looking at ownership structures for Property Investors.

Apart from the decision of which property to purchase, the ownership structure that you use is perhaps the most important decision you make when embarking on a rental venture. But unfortunately it is the one that many people fail to consider, or consider too late, sometimes with expensive consequences.

The ownership structure that you choose has taxation considerations as well as asset and wealth protection considerations. When reviewing your options you should make sure you are clear on your long-term goals and take all of these factors into consideration. You should never plan on tax effectiveness alone, in fact doing so can be considered to be tax avoidance. However, you will need to have an awareness of the effect your chosen structure will have on your taxation position, to ensure it is as tax effective as possible, while still achieving your other goals.

There are four main ownership options: a Company, Family Trust, Partnership or sole trader. As with all things there are advantages and disadvantages of each, and you should weigh these up against your own circumstances and seek advice from your Chartered Accountant and Solicitor as to which is the best option for you. Note, the following structures and considerations are also equally relevant for any investment or business venture.

Companies

A normal limited liability Company is a separate entity that purchases the rental property. Income can be retained within the Company and profit is taxed at the Company tax rate - currently 33%. Or the profits can be distributed to the shareholders where the profits are taxed the shareholders marginal tax rates. If the company has a taxable loss, the loss is offset against other income of the Company and any remaining loss is carried forward and offset against future income. Property ownership can be changed by transferring shares in the company rather than having to sell the property. A transfer of company shares avoids the complications associated with depreciation recovered on sale and the cost of transferring ownership of the asset.

Loss Attributing Qualifying Companies

Another option is a Loss Attributing Qualifying Company. This is a normal Company that elects to have a special status with Inland Revenue. The criteria to be met before applying for LAQC status includes a limitation on the number of shareholders. Any taxable profit the Company makes can be retained and taxed at the Company rate - currently 33% - or distributed to shareholders. The major attraction of a LAQC is that losses are attributed to shareholders in proportion to their share ownership. These losses are offset against the shareholders' other income, thereby reducing their overall taxable income. LAQC's offer the most flexible ownership structure for residential rental properties due to the flexibility with income and losses. LAQC's also allow shares to be transferred rather than selling the property. A disadvantage of an LAQC structure is that when the shareholders elect to become an LAQC they become liable for the Company's Income Tax should it become unable to pay. Ongoing administrative costs of Companies are generally also higher compared to other ownership structures.

Family Trusts

A Family Trust is a separate entity that can be used to purchase the rental property. Trustees can decide to either leave a taxable profit in the Trust or pay out income to beneficiaries. Profits left in the Trust will be taxed at the Trust tax rate - currently 33%. Distributions of income to beneficiaries are taxed at the beneficiary's own marginal rates, except in the instance of distributions to minors (those under 16 years of age) which will be taxed at the Trust tax rate. If the Trust has a loss for taxation purposes then it is offset against other income of the Trust and any remaining loss is carried forward and offset against future income. Losses cannot be attributed to beneficiaries. Disadvantages include higher set up and on going costs, but as mentioned earlier you need to weigh up the costs against the benefits for you.

If asset protection is a major driving factor for you to consider, then the right structuring over time with a Trust can achieve this. Your Chartered Accountant and Solicitor can advise you in this respect.

Partnerships

A simple structure whereby two or more people own a property jointly or as tenants in common. Any resulting taxable profit or loss is returned in the partner's tax returns in proportion to their ownership. A husband and wife partnership is generally an equal split. Again this is a simple structure, but gives little opportunity for tax effectiveness, asset protection or flexibility for the future.

Sole Traders

An individual owns the property and any resulting taxable profit or loss is returned in that person's income tax return along with any other income which they may have. This is a simple structure, but gives no opportunity for tax effectiveness, asset protection or flexibility for the future.

Once you have liaised with your team of professionals and chosen a structure, you should always ensure you understand this structure and any implications that arise from it. A complex structure may be what is required to meet your needs, however it may be ineffective if you do not understand it.

The above information gives an outline of the options for you to consider, and as always you should seek advice from your Chartered Accountant and solicitor before acting. The best time to get advice is early on, preferably before you put a contract on paper, however if you have already taken that step it is not too late.

Gavin Goodjohn is from Chartered Accountants, Staples Rodway Tauranga.

Disclaimer

No liability is assumed by Staples Rodway Tauranga Ltd for any losses suffered by any person relying directly or indirectly upon the article above. It is recommended that you consult your advisor before acting upon this information.

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