Commercial Property Ownership Structures - Which is right for you & mistakes to avoid
- Sapphire Bay Partners
- Oct 16, 2023
- 10 min read
Updated: Feb 27, 2024
Choosing the right property ownership structures is one of the most important decisions you will make at the time you purchase your investment property!
Some investors turn to their everyday accountant who don't understand the intricacies of different structures and many don't even ask their tax advisor at all - this costs them thousands or even tens of thousands of dollars annually and can be prohibitively expensive to unwind!
In today's feature article we look at some of the most common property ownership structures and consider which could be right for you. However, as any sophisticated investor would, this is certainly one area where you want to get specific, knowledgeable advice, from an advisor who specialises in this type of property acquisitions.
Get this decision right and you will maximise your returns and tax deductions long-term, meaning you keep more of your money working hard for you.
Get this decision wrong and you will be very sorry and may suffer financially for the entire period you own the asset (which could be decades!). You may also unwittingly make yourself more attractive to would-be litigants and creditors.
Therefore, it is important to get the right advice about property ownership structures BEFORE you settle on the purchase contract.
So let's dive in!
At a glance
There are various ownership structures to consider when purchasing a property. These include:
Direct ownership in your personal name
Ownership through a trust
Ownership through a corporate entity (e.g. an Australian Pty Ltd entity)
Within your Self-Managed Super Fund (SMSF)
Each structure has its advantages and disadvantages, as discussed below.
It is critical that you seek specialised assistance prior to finalising the acquisition to ensure the right structure is in place.
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Article - Commercial Property Ownership Structures
Considerations - What you should be thinking about prior to deciding your structure
When considering which structure to implement, you need to take a look at the broader picture of your financial affairs, both now and in the future.
Some of the criteria you will consider when deciding which commercial property ownership structures are best for you include:
Asset protection and the importance of it to you
Financial projections of the property, including if and when it will be profitable (i.e. is it negatively or positively geared?)
Your income and how it is derived (e.g. are you an employee or a business owner?)
Length of time you intend to hold the property
Succession planning
Potential changes to your personal situation (e.g. expanding family, nearing retirement, changing from an employee to a business owner)
How your other affairs are set up (e.g. do you have a bucket company to collect excess earnings?)
These considerations are critical to your decision about the correct ownership structure, as well as implementing the necessary flexibility in the structure so that if and when these change, your structure can quickly and efficiently adapt to your new needs.
We will discuss these considerations more in a future article, but in the meantime, lets look at the different ownership structures available to you.
Ownership Structure 1 – Private Ownership (i.e. in your own name)
Private ownership simply means that you own the property in your own name, either as an individual or jointly with another person.
If you are purchasing with another person you can choose to purchase it as Joint Tenants (equal owners, and if/when one of you pass away the deceased’s share of the property will automatically be transferred to the survivor) or Tenants in Common (the percentage of ownership and tax benefits of each party can be determined at the time of the purchase and each owner must nominate who their share of the property will go to in their will).
This can be popular as a property ownership structure as it is the easiest and cheapest ownership structure. It allows the investor to offset their property losses against other personal incomes. Therefore, negatively gearing your property, having high taxable income and being on a high tax rate will be beneficial for private ownership. You also may receive a 50% discount on capital gains tax when selling investment properties that you have held for more than 12 months.
On the other hand, there are two main downsides to owning an investment property in your own name. Firstly, there is no asset protection, which makes it a dangerous choice for many. This especially includes those who are self-employed or in high-risk occupations (like medical professionals). For example, all assets held personally may be at risk if a legal battle involves you. Another disadvantage is that there is no flexibility over how the property losses/gains will be distributed. For example, if the property starts profiting, the owner has no flexibility over how that profit is taxed. The income must be assessed (i.e. be included in a tax return) in the exact percentage you own the structure (e.g. 100% if you solely own it or in the ownership percentages if you own it with someone else).
At Sapphire Bay Partners, we try to be as straightforward and helpful as we can. So we will just say from the outset that this is generally not a structure we recommend, especially for sophisticated investors or those aspiring to be sophisticated investors. .
As the vast majority of our clients are sophisticated investors and/or business owners, this structure lacks the necessary asset protection and the advantages noted above can be achieved through other means. It also lacks the flexibility to be able to distribute and change the amount of income distributed between you and your loved ones.
The main advantage this structure has over the others is that it is easy to understand, maintain and implement. However, if you aspire to be financially independent and leave a lasting legacy, this is unlikely to be a structure we will recommend to you.
Ownership Structure 2 – Trusts
There are different types of trusts available depending on your personal situation. In essence a trust is where the legal owner of the property (the trustee) is looking after and holding the property for the benefit of other people (the beneficiaries). Note that the trustee can also be one of the beneficiaries. Creating a trust may help to protect your assets and legally minimise your tax liabilities.
The two main types of trusts that property investors use include discretionary trusts (sometimes referred to as family trusts) and unit trusts. Also worth mentioning are hybrid trusts which this article will be discussing below.
Overall, establishing a trust is relatively inexpensive, will give you greater control and flexibility to manage your portfolio in a tax-effective way (especially when your property portfolio is making a profit and/or as your property portfolio grows and land tax starts to be a problem), will give you extra asset protection and may help you to minimise your tax (including land tax).
Speaking frankly, the use of a trust in a structure (coupled with companies where appropriate) is one of the most common we see with sophisticated property investors outside of an SMSF.
However, there are a few drawbacks. These include:
Losses are trapped in the trust. This can be a turnoff for those investing in negatively geared properties, as you can't use the losses to offset your personal taxable income (though the losses can be carried forward and used to offset future income).
It's more complicated to understand
It will require setting up a trust, as well as a corporate trustee entity (we generally don't recommend individuals act as trustees unless there are compelling reasons to the contrary)
The ongoing maintenance is higher, in terms of fees and compliance
That said, for those with extensive portfolios, this is by far the most utilised structure to hold assets, especially commercial assets were income is expected to be derived from day 1.
For those wanting more detail about why the rich and sophisticated investors hold their assets in trusts, check out this article. While that particular article relates to business assets, the concepts are equally relevant when it comes to property investing.
Ownership Structure 3 – Companies
A company is a separate legal entity and is utilised by businesses and property investors alike.
Having the same rights as a person, it can incur debt, sue and be sued. The company’s owners (shareholders) can limit their personal liability and are generally not liable for company debts. A company can either own property in its own right or can be trustee of a trust that owns property.
A benefit to having a company is the tax rate on profits may be lower than your personal tax rate. This is because the company tax rate applies rather than the marginal personal income tax rates. It also offers strong protection of assets.
The main disadvantage of using a company structure for property investing is that companies do not get a 50% discount on capital gains tax (CGT) on the sale of investments like individuals and trusts. Companies are also only able to offset losses against future income.
When it comes to property investing, companies are less frequently used than trusts as holding structures. The main reason is due to the inability to obtain the CGT discount.
Ownership Structure 4 – Self Managed Super Funds (SMSF)
What is a SMSF?
A Self-Managed Superannuation Fund (SMSF) is a superannuation trust structure where the members are also the trustee of the fund. SMSF’s allow members more control over investment decisions on their superannuation. It give members the opportunity to borrow money to purchase investment properties within the SMSF.
The advantage of SMSF is the ability to allocate your retirement funds to property investing before you hit retirement age. It also enables you to get a 33% discount on CGT when you sell the property after 12 months.
However, the tax savings get even better if you buy a property with your SMSF and hold the property until you reach retirement age, when your tax rate drops to 0%, meaning you pay no tax on either the capital gains if you sell the property or the rent if you continue to use it as an investment property and the property is positively geared. Another benefit of an SMSF is the tax rate for SMSF’s is only 15%, which is significantly lower than personal tax rates.
A common play we see with SMSFs by business owners is to own the premises used in their businesses within the SMSF, thereby deriving income in a highly tax reduced environment, all while growing their nest egg.
Investing with SMSF
As well as the obvious attractive tax structure, using your superannuation to invest could be a great way to grow your property portfolio. With the limitation on your personal borrowing capacity, this is especially true.
When assessing a lending application for a loan to purchase a property within your SMSF, the lender will focus on the income and expenses of the SMSF and will not take into account your personal income and expenses. As a result, you may be able to borrow money in your SMSF, if the income received by your SMSF (i.e. through rental income and other income of the SMSF) is sufficient to service the debt.
It is important to note, that borrowing through an SMSF is always by way of a limited recourse loan, meaning that the bank’s ability to recover lost funds resulting from default are limited to the specific asset which is financed. If the SMSF defaults on the loan, the lender's rights are limited to the asset held in the separate trust. This means there is no recourse to the other assets held in the SMSF.
As a result, many lenders require the beneficiaries of the SMSF to personally guarantee the loan. Therefore, if your SMSF fails to meet the loan repayments you may be personally liable.
On the downside, SMSF’s are an expensive ownership structure to establish and maintain. This is due to their highly regulated and complex nature. SMSF’s are also the only ownership structure that you can’t use equity growth to fund or borrow against for future investments. This is a big limitation for investors in the acquisition phase of their investing journey.
There are also strict limitations regarding what improvements you can make to the properties in the SMSF. Therefore, this is definitely not the right ownership structure for properties you plan to add significant value to.
It is advisable to get the right advice before entering into an SMSF arrangement. There are various ongoing compliance and audit requirements and heavy penalties for getting it wrong.
Though generally speaking, this is an investment structure for very long-term holdings which serve a specific purpose.
So, what should I do when buying an investment property?
People buy investment properties to earn income and have their money work hard for them. It is one source of helping them get ahead.
Therefore, whether this is your first investment or your are an experienced investor, it is critical you do the following:
1. Consider your goals and financial strategy.
Think carefully about your options and make deliberate decision about how you will get there and what property types will help you achieve that goal.
2. Find a property that makes sound financial sense and is helping you achieve your goals and fits within your strategy
We sometimes have potential clients come to us seeking out negatively geared properties just to reduce their taxable income. We strongly discourage this.
There are specific strategic uses of negatively geared properties, but simply reducing your personal income tax is not one of those uses. That said, where appropriate, you can improve your financial position with a strategically acquired negatively geared properties.
However, the main takeaway is this: make sure that whatever you buy makes sound commercial logic.
3. Find a finance broker experienced in commercial property investing.
While you may think all property is the same, it absolutely is not, especially when the banks assess a transaction.
The loans in commercial property are very different products. The banks take different factors into consideration when assessing them and they are fundamentally different products and risk profiles. It is literally a different product type to residential loans.
Therefore, you should certainly not just go to your regular broker who helped you with your last residential acquisition, unless they also have extensive expertise in commercial property investing.
We can't stress this enough.
If you need a referral to excellent commercial property brokers, feel free to contact us at Sapphire Bay. We don't get any referral benefit from it. We are simply happy to point you in the right direction, whether you are a client of ours or not.
4. Consult an accountant or advisor that specialises in and has experience with property investing.
Depending on your accountant, you may need to engage a specialist, even if it is just to help you determine the best structure for you. You can then go back to your preferred accountant for ongoing accounting, which is much simpler and less complex.
The Closing Word
Purchasing an investment property is not something to cut corners on. Sophisticated investors always seek advice on how to structure their property investment. Getting it wrong can cost you thousands of dollars annually, whereas getting it right for the outset will allow you to make more money sooner and move you on to your next venture.
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Sapphire Bay Partners is always delighted to help!
We love working with dynamic, proactive clients and helping their businesses grow.
If you would like assistance, feel free to reach out to us.
Tel: + 61 3 9563 4666
Email: letstalk@sapphirebay.com.au
Important Information
This is general information only so it doesn’t take into account your objectives, financial situation or needs. Sapphire Bay Partners is not giving you advice or recommendations (including tax advice), and there may be other ways to manage finances, planning and decisions for your business.
Carefully consider what’s right for you, and ask your lawyer, accountant or financial planner if you need help. Alternatively, feel free to reach out to Sapphire Bay Partners for assistance or referrals to an appropriate professional. We’re always happy to help!
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