When buying an investment property there is an important decision all medicos need to get right from the start. With many decisions to make, such as property choice, location, budget range and so on, it is easy to get caught up in the excitement of this major asset purchase and neglect one of the most critical decisions. Choosing how to structure your property’s ownership is of upmost importance for a medico buying a property given each ownership type offers varying levels of asset protection and tax benefit.
While there is no one-size-fits-all solution when it comes to purchasing an investment property, there are many factors to consider.
Personal ownership provides the simplest nexus for claiming interest and rental deductions but it also usually provides the poorest level of asset protection. Individual ownership can incorporate many options in a family situation such as spouse ownership, joint ownership or ownership by the medical practitioner.
At the start of your medical career you may have minimal assets to protect so this structure may be an appropriate option. Conversely, as an established medico with accumulated wealth, you have a greater need for asset protection and owning an investment property in your own name may not be a smart move.
The harsh reality is that all medical practitioners carry the risk of being sued by patients as well as general life event risk. Despite insurances mitigating these risks to a certain degree, medical practitioners should be particularly wary when holding assets in their own name.
Tax benefits for personal ownership are certainly maximised in the early years for medical practitioners on the highest tax bracket and tax advantages of negative gearing are enticing. However consider the flip side, what happens when you come to sell the property? If there is significant capital gain on the property this will all be taxed in the medico’s name, which will likely be at the top marginal tax rate. There is no option for sharing the tax burden of this gain with your family members.
Limited asset protection versus increased tax benefit is the trade-off when buying a property in your own name. All personalities and circumstances differ and while asset protection may be of utmost importance to some, others will value greater tax benefit more.
Discretionary Trust Ownership
As your business and asset portfolio grows, medicos may need to separate business and personal risk. At that time purchasing and owning existing investment properties through a trust may provide a better level of asset protection. We explore the option of using a trust structure for holding property.
A trust is an arrangement where an individual or company (the trustee) legally holds assets for the benefit of one or more beneficiaries.
For common discretionary trusts, the specified beneficiary group will generally consist of family members. The beneficiaries will not have any fixed entitlements as the trustee has the discretion on how the trust’s income is distributed. For tax purposes this means that income, including capital gains, can be distributed to beneficiaries in the most tax-effective manner.
Further, subject to the trust deed, the tax law allows capital gains to be separately streamed to certain beneficiaries, possibly those with accumulated capital losses. This enables tax efficiency for the family group. Trusts, like individuals, are afforded the 50% discount when the disposed asset has been held for 12 months or more.
As a means of safeguarding your wealth against liability claims, atrust allows the practitioner to maintain control over the assets held, yet it cannot be sued as it is not a legal entity. A corporate trustee offers the best option for limited liability and succession reasons. It adds an extra layer of protection by keeping the legal ownership separate from the practitioner.
When considering whether to structure a property investment in a trust you should also note:
- Losses. If the property is negatively geared and the trust has no other source of income, there is no immediate tax benefit as the losses will be quarantined. However, provided the trust satisfies all requirements to carry forward the losses, they can be utilised to offset against future income. This usually occurs when debt has been paid down and the property becomes positively geared, i.e. rental income earned is more than the expenses paid.
- Compliance Costs. Upfront costs to establish a trust and possibly a corporate trustee need to be factored in. There are also ongoing bookkeeping and annual accounting and tax requirements for the trust, along with ASIC annual fees for the corporate trustee.
- Borrowing. Finance can be a more complicated, particularly with a corporate trustee, where directors’ personal guarantees will be required. Lenders may charge more in establishment fees due to the additional documentation and legal requirements of reviewing the trust deed.
- Land Tax. Land tax is applied at state government level, meaning each state has its own rules and thresholds. It is assessed on the total value of landowners’ holdings excluding their main residence. In Queensland, the taxable threshold for land tax on individually owned property is lower than that for trusts. This means additional land tax can be levied on a property held in the name of a trust.
- Estate Planning. Assets owned by a trustee on trust are not specifically covered by a Will. For medical practitioners purchasing property in a trust, the property continues to be owned by the trustee on death, allowing the flexibility of passing it on to the next generation, free of estate issues.
If possible threats to your assets concern you, purchasing your property in a trust will maximise the protection afforded to your assets. You work extremely hard to accumulate wealth so it is imperative to regularly review your asset protection strategies. These strategies are a combination of insurances and purchase structures. In a trust, up front tax benefits can be delayed for many years, so you need to weigh up the trade-off between tax benefits and asset protection for your particular circumstances.
Whether you buy your property in your individual name, jointly with your spouse, in your spouse’s name or in a trust, is a decision that should be made and reviewed with each property purchase. This needs to be considered and decided prior to the signing of a contract. If a decision is made to transfer the property later on, stamp duty and capital gains tax can be triggered, potentially making it a very costly exercise.
Negative gearing, capital gains tax and political risk relating to available structures can also impact on the decision making process. We explain these key considerations below.
Negative gearing is a popular and long-standing strategy where funds are borrowed to buy an income-producing property. The costs of running the property (at least in the earlier years) will outweigh the rental income generated, creating an investment loss.
The annual loss is deducted from the owner’s assessable income to reduce income that is subject to tax. If it results in a tax loss, in most cases that loss can be carried forward and offset against future income. Therefore, ownership structure has a large bearing on the timing and extent of any tax benefits. Individual ownership will provide more immediate tax benefit from negative gearing, while tax benefits can be deferred when an asset is purchased in a trust structure.
Capital Gains Tax
Subject to a number of exceptions, capital gains tax is imposed on the gain on disposal of assets. In general terms, this is the difference between the sale price and original purchase price. For rental properties, certain modifications to the calculation may apply. So long as the property has been held for longer than a year the capital gain is able to be reduced by 50%.
Capital gains tax is not a separate tax. Instead, taxable capital gains (net of capital losses) are included in the owner’s assessable income and taxed at their marginal tax rates.
Purchasing a rental property is about long-term wealth creation and maximising the owner’s financial position. As capital growth is the primary intention, potential capital gains tax exposure is an important matter that can be initially overlooked.
When a capital gain made on the sale of a property is substantial there can be a significant tax impact in the year of sale when this is taxed in an individual owner’s name. Alternatively, where a property is held in a trust capital gains can be flexibly distributed to family members to minimise the tax impact.
There has been much talk in the media lately in relation to Bill Shorten’s plan to tax trusts the same as companies. This is not a new idea and has been discussed at various times over the past 20 years. If this was put into effect the distribution benefits of trusts may not be as easily accessible without detailed further planning and structuring. In this situation a company may become another alternative structure for the purchase of an investment property. Companies are not usually considered as they have no access to the 50% capital gains tax discount. However they do offer some asset protection benefits and with careful planning may still be able to achieve tax efficiencies through dividend allocations.
Self-managed Superannuation Fund
Self-managed superannuation funds (SMSFs) can also be used as part of a total structure for building wealth. However, as the rules and restrictions for allowed investments under the superannuation legislation is complex, caution must be exercised before jumping in and buying an investment in an SMSF. Advice should be obtained to determine if a SMSF should be considered as part of your total structure.
Choosing the right ownership structure for your investment property can be a complicated and time consuming task. Political risk is always prevalent as tax law is continuously changing. This makes it extremely important to review your structures on an ongoing basis. As a medical professional we understand your life can be busy so to find out which structure is right for you, ask your accountant for advice specifically tailored to your situation. It is important you obtain this advice at the outset of any purchase decision so that there is time and opportunity to ensure the structure chosen is the best fit for your circumstances.
For more information on how Pilot can assist with your structuring, contact Angela Stavropoulos or Kristy Baxter on email@example.com or 07 3023 1300.