Different ways of structuring your finances
Getting your loan structure right can make a big difference to the amount of tax you pay over the life of a loan on an investment property, as well as how much you can borrow later on.
The ‘normal’ way to buy property in Australia is alone or with a partner/spouse but other options are available, like through a company, trust or a Self-Managed Super Fund (SMSF). Here are some pros and cons for each, but remember, professional advice is essential before getting started.
Buying as individual or partnership
The loan is under your name, or jointly with others.
Simplicity – Set up is straight forward and you’ll choose from multiple lenders, who may offer package discounts, offset , credit cards and other beneficial features.
Negative gearing benefits – any rental loss incurred can be offset against your taxable income. If negative gearing, just make sure the property’s long term value gain makes it worthwhile.
Capital Gains Tax (CGT) discount – if you eventually sell your property, you will be taxed on capital gain, but as an Australian resident, you may be eligible for a 50% CGT discount if the property has been held for at least 12 months.
Asset protection –the loan is in your name so you have little asset protection. If you were sued, your home or investment property could be in jeopardy.
The relationship ends – breakups can be messy. One party might need to buy the other out or you might need to sell the property to repay the loan.
Income tax costs – profits earned from your investment are considered taxable income and might push you into a higher tax bracket. If positively geared you could lose nearly half your profits in tax.
Buying through a company
The company owns the investment property and the loan. Directors are liable for the loan.
Gearing – Companies, like individuals, can benefit from negative gearing. If the property is positively geared the income tax payable within the company is capped at 30%, versus the top individual tax rate of nearly 50%. Note, fees may apply when the profits are withdrawn as dividends.
Asset protection – Your family home can be in your spouse’s name, so protected from litigation against the company.
Banking restrictions and rates – a business banker will likely manage your loan, meaning higher rates and fees. Also, not all lenders loan to companies, or offer them flexible features.
CGT discount – companies are not eligible except in rare circumstances.
Buying through Trusts
Trusts fall into two main types – unit or fixed trusts, and discretionary or family trusts. Not all are created equal when buying property!
Asset protection – if a beneficiary runs into financial difficulty, assets owned by the trust are protected from personal creditors.
Negative gearing -benefits are available, however losses are held in the trust until offset by profits.
CGT discount– Trusts, like individuals, are eligible for the 50% discount.
Easier to open and close – unit trusts are cheaper to set up and easier to shut down than a company. They have fewer regulations so can more easily be transferred and reacquired.
Complexity – there are costs involved in setting up trusts, plus ongoing fees and land tax rules (differing state by state). Trusts also come in many forms and not all are appropriate for property investing.
Stamp duty – when transferring a property from individual to trust, the trust is liable to pay stamp duty and the individual to pay CGT.
Buying using SMSF
The property is purchased by your Self-Managed Super Fund.
No saving for a deposit- as long as you have enough super accumulated.
Tax benefits– SMSFs pay the superannuation tax rate of 15% tax on rental income from the property, while interest is still deductible. Losses can also be offset on future taxable income. Once trustees hit retirement age, any of the fund’s rental income or capital gains will be tax free.
CGT discount – the fund receives a one third discount on capital gains made upon sale.
Must meet the “sole purpose test” – it can’t be bought from, lived in, or rented by a fund member or related party.
Loan hurdles –SMSF property loans can only be serviced using rental income and 9.5% of the SMSF trustee’s salary (like regular superannuation). Banks therefore usually require loan to value ratios of 50% or lower (rather than the 80% considered the norm for individuals) and are unlikely to lend to an SMSF with a balance below $200,000.
Tax and cashflow – you can’t offset losses against your taxable income and all repayments must come from your SMSF. Yet, your borrowing power for investments outside your super is negatively affected by your SMSF loan.
Altering the property – you may not alter or improve a property, only carry out certain repairs.
Structuring your finances is something you want to get right from the start of your journey, or it can be costly trying to undo mistakes in the future.
If you want to know what the best option is for you and your personal circumstances, book a consultation with our team and they can point you in the right direction.