You can own an investment property in your own name, in a partnership or a limited partnership, in a company, in a look-through company or in a trust.
The different entities have different costs to set up and maintain.
Risk mitigation and tax are also factors in considering which ownership vehicle is best.
When investing in property, lots of effort goes into finding the right kind of property, in the right location, with the right yield, at the right price — all of which is obviously important.
But there’s another factor that often doesn’t get enough consideration — which entityshould own your investment?
There are myriad options — you can own the investment in your own name, in a partnership or a limited partnership, in a company, in a look-through company or in a trust.
The advice as to the “best” option has also shifted over the years, which can make the decision process confusing. But instead of picking the “best” option, you need to opt for the “right” one for you — a decision that should be guided by a chartered accountant and potentially also a lawyer.
My aim here is not to tell you which entity is either “best” or “right” but why the entity matters, and what you need to be weighing up in making that decision.
Start with the basic elements — like the cost and complexity of setting up and maintaining that entity. For example, owning it in your own name or in a partnership is very simple, with no real set-up costs or ongoing ones, beyond annual accounting. A company or look-through company, however, requires more of both, and a trust tends to be the most expensive and complex to administer over the long term.
Outside cost and complexity, other issues worth considering are often not obvious at the beginning of your property investment journey.
Risk mitigation is the first benefit that’s often cited as a vote in favour of a trust or a company. If you ask the experts what those risks are, tenants and creditors are usually the answer.
Given we have ACC and a largely “no-fault” system, my assumption has always been that the risk of a tenant suing you for injury or damages is low — but I’d be keen to hear otherwise from those with experience of that. And low risk does not mean no risk.
If you own a business, a trust can help protect personal assets from creditors in the event your business can’t pay its debts. However, when you fund the assets of the trust with debt, the lender will require a personal guarantee — so a trust is not going to stop the bank from chasing you for that debt. But it would provide asset protection against unwanted claimants in the future as you can specify who benefits (and who doesn’t) from the trust.
The next thing to consider is your plans for those assets — even though any changes might be a long way off.
Let’s say you bought two properties in a limited liability company structure many years ago, and now want to sell one of them to help fund your retirement. The sale is outside the bright-line (capital gains tax) period, so no tax is payable on the profit.
Herald columnist Nadine Higgins. Photo / NZME
However, because the property is in a limited liability company with another property, your only option to extract the profit for your personal use — short of winding the company up — is to pay it out as a dividend, which would be taxed. When you’re close to retirement, the impact of that tax bill is likely to be a big hit to the amount you were expecting to have, with precious little time to make it up elsewhere. If you’d had those properties in a trust, or a look-through company, you could have extracted the profit without a big tax bill.
If the idea of ownership entities and structures all sounds a bit overwhelming, this might reassure you: principal at accountants McQueen and Associates, Catriona Knapp, says her recommendation at present is often quite simple — that newbie investors own the property in their own names.
“It reduces your set up costs, your compliance costs, and it’s a lot easier for clients to get their heads around — plus it opens the door for restructuring down the track.”
What she means is the entity you choose to settle the property into can be changed at a later date. You might do that if you’re worried the entity won’t serve you well long-term, you’ve set up a business and want to minimise risk to personal assets, or you want to restructure debt.
I was probably being a bit ambitious trying to squeeze so much accounting into one column — especially when it tends to be a dry subject — but let me try to make this simple and succinct.
To shift your investment into another entity, you effectively sell it from one to another. It does mean if you’re within the bright-line period, you may have tax to pay on any gains, and it also resets the bright-line start date — so you need to think about when you plan to sell it.
If you own it in your personal name and sell it to, say, a look-through company, the company buys it at the current market price. For example, you bought the property for $600,000, it’s now worth $850,000, and you owe the bank $400,000. The new entity borrows to buy it for $850,000, meaning all debt against that property now sits within the look-through company, and net of your bank debt you receive $450,000.
The property now belongs to the company, interest on the debt is tax-deductible and you could make the debt interest-only, which allows you to put more of your money into repaying personal debt and pay it off faster. That can release capital (ie you benefit from the gain in value of the property without having to sell it), improve your cash flow (as repayments for interest-only debt are lower) and may unlock other options to continue to invest.
It’s always advisable to seek professional advice — but it’s also worth understanding why you would — and I hope this helps you with that.
