The way an investment property is owned can make a huge difference when it comes to the amount of tax that needs to be paid.
It’s essential for investors to carefully consider how the ownership of their properties is structured, and also the potential impact of land tax on their property’s return.
What is a discretionary trust?
When it comes to structuring an investment property to minimise tax, the best approach depends on the investor’s circumstances, according to accountant Nathan Watt from Watson & Watt.
Aear the trustees get to decide which beneficiaries receive a distribution, how much the distribution is and, depending on the terms of the trust deed, what class of income they will get,” Watt says.
For example, they may be able to give capital gains income to an individual with capital losses and the rental profit to a company that pays 30 per cent tax, rather than distribute the profit to an individual on the highest marginal tax rate of 45 per cent.
In contrast, owning a property as individuals, either solely, as joint tenants or as tenants in common, doesn’t provide any discretion on how the net rent or capital gain will be distributed.
But trusts also have limitations. If the property is negatively geared and held inside a trust with no other income going into that trust, losses can’t be used by the beneficiaries to offset other income. Rather, the loss is carried forward inside the trust, until such time as the trust has a profit, subject to the trust satisfying the carry forward loss tests.“If the property is held by individuals in their own names, they could offset the loss against their salary and wage income, thereby reducing income tax along the way,” says Watt.
As a result, trusts are often best used when building a portfolio of assets for long-term investing, with the trust the owner of all the investments. Some of the properties may be negatively geared and others may be positively geared, to make the most effective use of any losses to minimise tax.
“Business owners are good candidates for discretionary trusts, as trusts can own the shares in the company that runs the business,” Watt says. “The trust can receive the dividends from the company and also offset any losses on the property against this income.”
“A trust may also reduce their assets at risk if they were to be sued or the business fails,” he adds.
Owning the property for more than 12 months also results in a 50 per cent capital gains tax discount. If the property is held in a self-managed super fund, capital gains tax of 10 per cent instead of 15 per cent is payable if the property is owned for longer than 12 months.
Common tax mistakes
There are many common mistakes people make when it comes to claiming tax deductions for investment properties. “You can’t claim expenses for any period during which the property is not available for rent, such as when you stay in it,” says Watt.
Additionally, any repairs you make just after you buy it are not deductions. They are added to the cost of the property and reduce your capital gain when you sell it.
Many people are not aware of all the tax deductions they can claim for their property, according to Freedom Property Investors managing director Lianna Pan.
“There are up to 200 items that you can claim in your property as depreciation benefits.” Garbage bins and new grass are just some examples.
Pan says people are often not aware of land tax thresholds. Once these are exceeded, land tax can be substantial. “A lot of people don’t realise that until they get a huge land tax bill. But if you structure your purchases correctly, you can minimise your land tax.”
Watt says land tax thresholds are different in each state. “For instance, there is no land tax on the first $599,999 of taxable land value for individuals in Queensland. So a strategy might be to have different properties in different names, rather than having all properties in the higher income earner’s name for example. The main residence is exempt from land tax.”
It may also be appropriate to put the higher-value properties in individual names and lower-valued ones in the trust to reduce land tax. Also consider the net rent, capital gains tax and asset protection when making structuring decisions.
It is possible to contest the land value if you believe it has been wrongly assessed, but this isn’t an easy – or cheap – process.
There are many considerations to make when investing in property to reduce the tax payable and maximise the return. Before buying, work through different scenarios for the property to make the most of your asset over time.
discretionary trust is a popular option as it provides income distribution options and splits capital gains among the beneficiaries.
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