Choosing an ownership structure is one of the most common and challenging aspects of acquiring a property. Most investors only think about it during the closing in the buying process which can result in delays and an increase in professional fees. Knowing and understanding a property’s ownership structure in advance will not only save you time and money but it will also save you from all the unnecessary stress.
Reasons Why You Should Identify a Property’s Ownership Structure
One of the most important ways to protect your property investment is to establish an ownership structure that is suited for you since it has a significant impact on the following:
Tax. The type of ownership structure has a huge impact on the amount of tax you have to pay from the income you derive from the property. A tax-efficient structure ensures that your overall taxation position is optimized.
Administration. Property ownership structures allow you to have different levels of control with your assets depending on what you choose.
Protection. Life is full of liabilities and you have to consider and quarantine these potential liabilities to the maximum extent possible. Different property ownership structures offer various levels of asset protection.
Relationships. Pooling resources from friends or family can make it easier for you to buy a property but it might also lead to problems later on. If you choose to buy a property with one or more individuals, then it is important that you have a proper legal agreement in place.
Succession and Exit Strategy. We’re not going to live forever so you need to take into account the succession of the property you own. There are ownership structures that allow you to lock in who will control the trust upon your passing while providing ancillary taxation benefits.
Ownership Structures Used for Buying Property
The following are the most common types of property ownership structures.
Individual
This is the simplest type of ownership structure where a person buys and holds an asset in the owner’s personal name. This is what individuals owning single-family homes use. The benefits of having a property in your own name are that all of the benefits such as taxes, tax depreciation, and tax losses, are assigned to you and you only for the purpose of saving income tax.
The downside of this type of ownership structure is that you have little to no asset protection. Anyone who is suing you can attack the assets you hold in your name and therefore you are more exposed to the risk of losing the property in event of bankruptcy.
Partnership/Joint Venture
A joint venture happens when two individuals choose to buy a property together. However, it is also important to consider the percentage of holding when choosing this ownership structure.
Joint Tenants. This means that the two owners hold the property equally between them and the income or loss from the property will also be split equally.
Tenants in Common. This type of property ownership allows shares in the property to be divided unevenly between owners. Profits or losses of the property can be split according to the percentage of ownership.
Company
This is when your property is owned by a trust managed by you or others. When you buy assets through a company, you are guaranteed protection since the shareholder’s liability is restricted only to their contribution to the company. This ownership structure is best for high-income earners because the profit is taxed at a flat rate of 30%.
Look-Through-Company (LTC)
This is the ownership structure where your property is owned within a ‘transparent’ company structure where you report profits or losses on your personal tax return. The main benefit of this type of structure is the ownership can be tweaked according to the income and tax rate of the owners.
Additionally, with LTC, you have the benefit of limited liability, the legal structure that is a separate entity yet still under your control and is treated as a partnership when it comes to tax.
Trust
This is the type of ownership structure where the property is owned by a trust managed by you or others. When you transfer your assets to a trust, that means that you don’t own your assets anymore, the trust does. However, this is a good way to protect your property from unwanted claims and from creditors to whom you have given personal guarantees.
Generally, there are two types of trusts; Unit Trust and Discretionary Trust:
- A Unit Trust – It is an unincorporated mutual fund structure that allows funds to hold assets and provide profits that go straight to individual unit owners instead of reinvesting them back into the fund. This type of trust is a good alternative to joint ownership.
- A Discretionary Trust – It is a trust that has been set up for the benefit of one or more beneficiaries, but the trustee is given full discretion as to when and what funds are given to the beneficiaries. This type of trust provides flexibility to distribute income to the person on the lowest tax rate.
Self-Managed-Super-Fund (SMSF)
A self-managed super fund (SMSF) is a superannuation trust structure that provides benefits to its members upon retirement. This type of fund allows you the most flexibility and options for owning investments like property.
Choosing the Right Ownership Structure
When you choosing an ownership structure, you must consider the following factors:
- Whether you wish to own it individually or jointly
- Whether you wish to protect your assets
- Who will receive the income from the investments
- Your long-term property ownership goals
- Your financial circumstances
- Your income level and tax rate
There is no one-size-fits-all solution when it comes to structuring property ownership because everyone’s situation is different. Most people don’t understand the differences and ramifications of the various property ownership structure until it is too late to change them. The trick is to find the right structure for each situation by consulting experts who will protect your assets from the risks of bankruptcy.