Property Investment Tips for Small Business Owners

As a business owner, when it comes to buying property, whether for investment purposes or otherwise, there are a lot of decisions to be made. As accountants the question of what entity to purchase the property under, also referred to as the ‘property investment structure’ is one of the most important considerations for business owners.

If you’re a first-time investor, this consideration may not even have occurred to you.

Even more experienced property investors find the question of structures confusing. The final structure you choose will have an impact on not only the property’s ownership, but the taxes applicable to the purchase and sale of the property, and even the finance that’s available to you.

Let’s review the most common structure types.

1. Individual Ownership

The most common and cheapest way to purchase a property is as an individual. This may include purchasing the property with a partner or a spouse, in which case, both names will appear on the loan documents and other paperwork.

Benefits include:

• Purchasing as an individual (or with a partner) is that the loan process is relatively simpler
• Additional tax incentives or government support programs are available
• Buying as an individual can be a great option for many high-income earners, if the property is negatively geared, as it can lower taxable income. Individuals may also be eligible for the 50% CGT discount.

There is a drawback.  When purchasing as an individual – that is to say, without a company or a trust involved, your financial and legal responsibilities are not limited or protected. This means that the individual owners of the property are liable legally for the property. For example, if you were to be sued, you (and your partner) would be liable for the outcome.

2. Joint names

Buying property in a joint venture has a couple of key advantages. For starters, it allows friends or associates to pool their funds to purchase investment property. This lowers the barriers to getting into the market, as you can combine your funds for a deposit on the property.

It also means that you can apply jointly for a loan on the property and should be able to afford more than you would be able to if buying as an individual. Once again, there are downsides to this type of structural arrangement.

Firstly, if no formal agreement is in place with regards to the ongoing costs of the property, things can be a little tricky. Doing business with friends may seem like a great idea, but when it comes down to paying to replace the hot water system, disagreements can arise. The most important thing to do is to have an agreement in place which clearly outlines who is liable for what costs, and to what percentage. Be sure that all parties are clear on their rights and obligations to avoid later conflict.

3. Company Ownership

One way to limit your legal and financial liability is to purchase property as a company. A company may attract a lower rate of tax on any net rental income from the property, and individuals will be protected from liability to an extent. If you’re paying the higher rate of income tax, and you don’t have a lower-earning spouse whose name the property income could be put into, the lure of paying the much lower rate of company tax is going to be strong incentive.

In the event that a property you want to buy will be positively geared and the rental return is higher than your mortgage repayments, purchasing the property in your own name could result in you paying up to 47% on the net income.(Residents)

However, for properties with a positive cashflow that are purchased through a company, income tax is capped at a significantly lower 30% (based on passive income) – which could mean a great deal of difference to you take home earnings. The base tax rate of 25% applies to companies with an aggregated turnover threshold of $50 million (if income is considered business income).

The negative aspects of buying property include not receiving the 50% CGT discount, that capital can be hard to access (for example, to purchase further properties) and that any losses incurred can only be deducted from future income. Furthermore, a company can be quite expensive to set up and maintain.

4. Trusts

Trusts, like companies, can protect the legal and financial liabilities of the parties involved. A trust is a legal entity set up to manage assets for the trusts’ beneficiaries, and if set up properly, can offer a way to protect their assets. Although, they can be complicated and expensive to set up, just like a company. While a trust is often eligible for the 50% CGT discount, it cannot claim the first home buyer’s grant, and cannot be used to claim losses against taxable income. Meanwhile, it can make the dividing of profits and assets easier, when the time comes.

For those wishing to have extra asset protection, a trust can be a good solution. However, for negatively geared properties, a trust may not be the way to go, as the losses cannot be deducted from personal income tax and therefore remain within the trust.

5. Self-managed super fund (SMSF)

Purchasing property through a self-managed super fund has become more popular in recent years. Pooling your superannuation assets with other parties, as with a partnership or joint venture, means that your borrowing capacity is increased. Using your superannuation to purchase property can also save you from having to come up with a cash deposit. It should be noted however, that purchasing property in a SMSF structure is subject to strict government guidelines.

For starters, the investment must meet the ‘sole purpose’ test, which determines whether the investment is in the best retirement interests of the parties involved.

The benefits of buying property through a SMSF include being able to pool assets, offset tax (tax on superannuation is 15%, and only 10% after the asset has been held for 12 months) and reduce taxable income by making pre-tax contributions, and having greater control over your superannuation investments.

The downsides include not having a personal interest in the property (for example, not being able to rent to a relative), not benefitting from negative gearing, and having your super tied up in a fairly non-liquid asset. Furthermore, the purchase can be costly and complicated to organise.

Which structure should you choose?

Depending on your long-term plans for the property, there may be several options open to you when it comes to structuring your property investment. While it might be easier and cheaper for married couples to borrow together, there can be certain benefits to borrowing in one partner’s name or the other, for tax reasons. On the other hand, for those wishing to limit their liability and protect their interest in other assets, a company or trust structure might make the most sense.

As this issue is very complex, it is important to seek advice from your accountant, mortgage broker and solicitor. Being aware of the benefits and drawbacks of each structure, as well as what your borrowing capacity will be under each, will help you to make the most informed decision for your property investment.

So the question for company owners is what are the main advantages and disadvantages of purchasing property via a company. Deciding to buy property within a company structure raises a number of key questions that you should consider.

Are you a trader or an investor?

The first important distinction to draw when making this decision is whether you’re a property trader or investor. If you buy a property to make value-adding improvements and sell on for a profit, you’re a trader. In this case you’re likely to be best off buying as a limited company. Because when trading properties as a limited company you will pay corporation tax on your profits. If you’d bought a property to “flip” as an individual, your gains would be taxed as income – which, if you’re taxed at the higher rate, will be a whole lot more.

As an individual you might be able to get the profit treated as a capital gain rather than income if you could prove that you intended to rent the property out, and maybe did for a short time before selling it.

If you buy a property to collect the rent and watch its value increase over the years, you’re an investor. Most investors have historically operated as sole traders, but many will now benefit from using a limited company.

What are the benefits of using a company to do property investment?

From a purely financial perspective, there are three obvious reasons why you might want to hold property as a company rather than yourself.

Tax Treatment of Profits

If you own a property in your own name, the profits you make from renting it out will be added to your other earnings (such as from your job) and taxed as income tax. But if instead you hold it within a company, the profits will be liable for company tax instead. The rate of company tax tends to be lower than your individual tax rate. You will still be taxed on the dividends if you take profits out of the company, but there’s flexibility. You can time your dividend payouts for maximum tax-efficiency, or distribute them to family members who are only basic rate taxpayers – or just leave the profits rolling up within the company to buy the next property.

Opportunities to mitigate inheritance tax

Property held within a company gives more options when it comes to planning for Inheritance Tax. You should consult a property tax specialist if passing properties on, but you can make use of trust structures. If you can gain an income tax advantage and reduce future taxes a company structure may be a better option. If you’re paying the higher rate of income tax, and you don’t have a lower-earning spouse whose name the property income could be put into, the lure of paying the much lower rate of company tax is going to be strong.

What are the disadvantages of using a company to purchase a property?

There are some potential downsides as well.

Mortgage Availability

This used to be a major drawback.  Mortgages for companies were limited, expensive and had lower borrowing limits. The number of products on offer for companies is still much lower than for individuals, but it’s changing rapid as more investors are moving in this direction, lenders are following in order to win their business.

You will still need to give a personal guarantee and your own finances will be scrutinised, so in many ways it’s a personal mortgage in all but name. While you won’t find quite as many options and the rates and fees are likely to be higher, it’s less of a dealbreaker than it once was.

Dividend Taxation – Withdrawing money

If you’re leaving your rental profits in the company then there is no issue. But if you’re taking the money out (to spend on your own living costs, for example), you’ll be taxed on the dividends you take. That means you’ll be paying company tax first, then possibly paying a top up tax when drawing out depending on your marginal rate of tax at the time of paying the dividend.

If you want to live off your property income rather than leaving it to accumulate, it’ll be a bit of a toss-up. You’ll save tax in some ways but incur extra tax in others. You have to weigh up  the numbers to work out which will work out best in your situation.

Extra Costs

There are higher accountancy costs associated with filing annual company accounts – so that’s an expense to factor in. But most of the accounting work required is done by your accountant.

One other factor to consider is an exit strategy. For many property investors developing an exit strategy is important. Do you plan to sell your property portfolio off to finance your retirement, or is it important that you pass your portfolio on to your children or grandchildren?

There are a lot more factors to consider, when purchasing property through a company as we always recommend that you seek professional advice from your accountant/financial advisor or solicitor.

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Before making an investment decision based on this advice you should consider, with or without the assistance of a securities adviser, whether it is appropriate to your particular investment needs, objectives and financial circumstances. In addition, the examples provided on this page and on this website are for illustrative purposes only.

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