When a family elects to buy an investment property, one issue must be addressed first. Who in the family, or what other legal entity, should be the purchaser?
Estate planning is common sense. Planning at the acquisition stage, with an eye to family law rights, implications of other Australian Law on property rights and inheritance may sound cold and calculating. However, the reality is that while dispute avoidance is important, taxation and commercial legal issues are critical.
Let’s consider the advantages and disadvantages of three main alternatives: individuals, a company, or a family trust.
Individuals can buy singly or jointly. Usually couples purchase property as joint tenants, so if one dies the property will transfer to the other. All income, losses and capital gains are shared equally.
If negatively geared, consider whether the highest income earner should own the property to maximise the benefit of tax deductions. But remember, if the property is sold, the capital gain is made by that partner at the higher tax rate. Individuals who make a taxable capital gain on investment property owned for at least 12 months generally receive a 50% capital gains tax discount.
If the property is to be shared between family members, buying as tenants in common allows shares to be fixed in proportion to contributions, and all income, losses and capital gains are shared between the co-owners in that proportion.
Companies are not usually the ideal vehicle to purchase investment property as they do not receive the capital gains tax discount. If a company wishes to distribute after-tax profits to its shareholders, the shareholders will pay tax on those profits with credit being given for the tax already paid by the company. There may be problems if the shareholders divorce and the property is to be conveyed to one of the couple as part of a property settlement.
Discretionary, Fixed and Testamentary Trusts
Properties can be owned by a family trust. The trustee is usually a company. The advantage is the trustee can decide each year how to distribute the net income among the beneficiaries, and the beneficiaries pay tax at their marginal rate. The trustee can also distribute capital of the trust among the beneficiaries at its discretion.
Liability for income and capital gains tax depends on the nature of the trust and its distributions. Expert legal, accounting and financial advice should be sought on these matters as tax can follow distributions and losses can be locked into the trust to be carried forward.
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