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Yet more stuff from This morning's Sunday Star/Times
Landlords need ownership tips
15 May 2005
By ROB STOCK
Many property investors do not know their partnership from their LAQC, or their trust from their company, residential property experts say.
Kiwis are almost obsessed with achieving financial freedom through buying property, but it seems many need to learn how to own their properties.
A recent survey by BankDirect and landlord magazine KPI found 38% of those surveyed owned their properties in their own names, rather than through family trusts, LAQCs (loss attributing qualifying companies) or partnership agreements, says KPI editor Gez Johns.
A further 37% had never had a chattels valuation which is necessary to claim depreciation tax relief, a key way to help pay for a rental property bought with a big mortgage.
Andrew King, president of Auckland Property Investors Association, says few property investors should hold their properties in their own name.
Sunday Star-Times asked King to explain the options open to investors:
Owning a renter in your own name:
A no-no for King, even though it's the usual Kiwi way to own a renter.
The pros of this form of ownership are that it's clean and simple, and doesn't add to your legal bills.
You can claim depreciation tax relief on the asset (which you have to pay back, if you sell for a profit), and offset that against your tax in the year it is claimed.
If your investment property is loss-making, those losses can be used to reduce your income tax bills.
But holding a property in your own name gives none of the protections of a family trust or the flexibility of a LAQC.
Not only can creditors get at it, but if it is passed on in your will the IRD will treat that as a sale and any depreciation claimed will have to be paid back immediately by your estate.
Using a partnership:
If there are two names on the house deed of purchase, a partnership exists. That allows a number of people to co-own the property, and in almost every way they are in the same position as people who own their property in their own name.
King says some people draw up a partnership agreement.
This is a legal agreement that might, for example, allocate profits or losses unevenly. For example, 75% of the losses on a negatively geared property could be allocated on the basis that one person does most of the maintenance and management.
That will be the partner with the higher tax rate, of course.
Similarly, if the property is making money, the partner with a lower tax rate can receive a bigger share of the profits.
Does the IRD mind?
The answer is don't push it, says King.
Profit sharing relationships can't be changed for three years, and you have to be able to show profit and loss allocation is related to the effort and capital each partner introduced to the partnership.
Once again there's none of the asset protection of a family trust.
Owning a renter in a company:
It's relatively cheap and easy to set up a company - though more expensive to wind them up - and companies are taxed at 33%, so that would seem to be a gain for investors with high personal tax rates.
Like partnerships, a company allows multiple ownership. This could be useful, but, says King, there are better ways to achieve that.
The main drawback is that tax losses are held within the company. They are stored up against future profits, but can't be used to reduce shareholders' income tax.
Loss attributing qualifying company (LAQC):
Holding a rental property in an LAQC is like holding it in a company, although there are some basic differences.
If your rental property is losing money, an LAQC allows those losses to be passed on to the company's shareholders to offset against their personal income in the year those losses occur.
For example, an investor earning $90,000 a year, with an investment property portfolio losing $15,000 a year, should be paying tax on $75,000. That equates to a tax refund of $5850 (39% tax rate multiplied by $15,000).
But if an LAQC is owned by a mum and a dad, and she earns more than he does and pays tax at a higher rate, more than 50% of the shares in the company can be owned by her which will be worth more in tax refunds.
Shares can be transferred between partners if circumstances change.
By selling the shares of an LAQC, property within the LAQC that has grown in value, can be sold into a trust without any depreciation claimed having to be paid back, though King warns that investors need to take advice from a property tax specialist.
Shares in an LAQC can also be passed on as inheritances without incurring an IRD depreciation tax claim.
Another benefit is that "accidental" residential property investors, who buy a second property and rent out their first home can use an LAQC to avoid getting into a tax bind, says King.
Tax relief on the interest on a mortgage for a renter can be claimed, but only if the house was bought to be a renter - a trap which catches many accidental investors.
But sell that first home to an LAQC and that house has been bought as a renter.
Use the cash to buy the new home, and use the LAQC to take out a mortgage on the old one, and claim the tax relief.
Selling your family home to an LAQC and then "renting" it back to live in is likely to be viewed as tax evasion.
Family trust:
When you shift a rental property into a family trust you no longer own it. The trust does.
That has its pros and cons for the property investor.
The aim of a trust is to safeguard assets for future generations.
But it is also a way for business people with a high likelihood of being sued by creditors to be "poor" and make their assets untouchable.
That's a big pro, but the cons mean a family trust is a good way to own a house on which the income more than covers the costs - one that is not losing money.
If your renter is loss-making, the tax losses can only be stored up for later use by the trust.
That may not be a bad thing, says King.
Plan ahead - if a loss-making property will go into the black in, say, five years, it may be best to buy it through the trust. If you don't then you'll have to gift the property to the trust in five years' time, and you can only gift it at a rate of $27,000 a year, or $54,000 for a couple.
If you have plans to buy 10 properties it won't take long until you simply can't gift them to the trust quickly enough.
Gifting property worth $1 million would take a couple 18 years, and they wouldn't have complete asset protection until then.
Another benefit additional is that the income of a trust asset is taxed at 33% which benefits 39% taxpayers.
15 May 2005
By ROB STOCK
Many property investors do not know their partnership from their LAQC, or their trust from their company, residential property experts say.
Kiwis are almost obsessed with achieving financial freedom through buying property, but it seems many need to learn how to own their properties.
A recent survey by BankDirect and landlord magazine KPI found 38% of those surveyed owned their properties in their own names, rather than through family trusts, LAQCs (loss attributing qualifying companies) or partnership agreements, says KPI editor Gez Johns.
A further 37% had never had a chattels valuation which is necessary to claim depreciation tax relief, a key way to help pay for a rental property bought with a big mortgage.
Andrew King, president of Auckland Property Investors Association, says few property investors should hold their properties in their own name.
Sunday Star-Times asked King to explain the options open to investors:
Owning a renter in your own name:
A no-no for King, even though it's the usual Kiwi way to own a renter.
The pros of this form of ownership are that it's clean and simple, and doesn't add to your legal bills.
You can claim depreciation tax relief on the asset (which you have to pay back, if you sell for a profit), and offset that against your tax in the year it is claimed.
If your investment property is loss-making, those losses can be used to reduce your income tax bills.
But holding a property in your own name gives none of the protections of a family trust or the flexibility of a LAQC.
Not only can creditors get at it, but if it is passed on in your will the IRD will treat that as a sale and any depreciation claimed will have to be paid back immediately by your estate.
Using a partnership:
If there are two names on the house deed of purchase, a partnership exists. That allows a number of people to co-own the property, and in almost every way they are in the same position as people who own their property in their own name.
King says some people draw up a partnership agreement.
This is a legal agreement that might, for example, allocate profits or losses unevenly. For example, 75% of the losses on a negatively geared property could be allocated on the basis that one person does most of the maintenance and management.
That will be the partner with the higher tax rate, of course.
Similarly, if the property is making money, the partner with a lower tax rate can receive a bigger share of the profits.
Does the IRD mind?
The answer is don't push it, says King.
Profit sharing relationships can't be changed for three years, and you have to be able to show profit and loss allocation is related to the effort and capital each partner introduced to the partnership.
Once again there's none of the asset protection of a family trust.
Owning a renter in a company:
It's relatively cheap and easy to set up a company - though more expensive to wind them up - and companies are taxed at 33%, so that would seem to be a gain for investors with high personal tax rates.
Like partnerships, a company allows multiple ownership. This could be useful, but, says King, there are better ways to achieve that.
The main drawback is that tax losses are held within the company. They are stored up against future profits, but can't be used to reduce shareholders' income tax.
Loss attributing qualifying company (LAQC):
Holding a rental property in an LAQC is like holding it in a company, although there are some basic differences.
If your rental property is losing money, an LAQC allows those losses to be passed on to the company's shareholders to offset against their personal income in the year those losses occur.
For example, an investor earning $90,000 a year, with an investment property portfolio losing $15,000 a year, should be paying tax on $75,000. That equates to a tax refund of $5850 (39% tax rate multiplied by $15,000).
But if an LAQC is owned by a mum and a dad, and she earns more than he does and pays tax at a higher rate, more than 50% of the shares in the company can be owned by her which will be worth more in tax refunds.
Shares can be transferred between partners if circumstances change.
By selling the shares of an LAQC, property within the LAQC that has grown in value, can be sold into a trust without any depreciation claimed having to be paid back, though King warns that investors need to take advice from a property tax specialist.
Shares in an LAQC can also be passed on as inheritances without incurring an IRD depreciation tax claim.
Another benefit is that "accidental" residential property investors, who buy a second property and rent out their first home can use an LAQC to avoid getting into a tax bind, says King.
Tax relief on the interest on a mortgage for a renter can be claimed, but only if the house was bought to be a renter - a trap which catches many accidental investors.
But sell that first home to an LAQC and that house has been bought as a renter.
Use the cash to buy the new home, and use the LAQC to take out a mortgage on the old one, and claim the tax relief.
Selling your family home to an LAQC and then "renting" it back to live in is likely to be viewed as tax evasion.
Family trust:
When you shift a rental property into a family trust you no longer own it. The trust does.
That has its pros and cons for the property investor.
The aim of a trust is to safeguard assets for future generations.
But it is also a way for business people with a high likelihood of being sued by creditors to be "poor" and make their assets untouchable.
That's a big pro, but the cons mean a family trust is a good way to own a house on which the income more than covers the costs - one that is not losing money.
If your renter is loss-making, the tax losses can only be stored up for later use by the trust.
That may not be a bad thing, says King.
Plan ahead - if a loss-making property will go into the black in, say, five years, it may be best to buy it through the trust. If you don't then you'll have to gift the property to the trust in five years' time, and you can only gift it at a rate of $27,000 a year, or $54,000 for a couple.
If you have plans to buy 10 properties it won't take long until you simply can't gift them to the trust quickly enough.
Gifting property worth $1 million would take a couple 18 years, and they wouldn't have complete asset protection until then.
Another benefit additional is that the income of a trust asset is taxed at 33% which benefits 39% taxpayers.
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