Best entity to own mortgage free rentals for retirees

[chrisgoh]

Assuming a couple is preparing for retirement and plan to live on rental income. All the rental properties they intend to invest including their home will be mortgage free. In this scenario, what is the best entity to execute the plan in order to minimize tax and protect the assets? Trust? LTC? Partnership? others?

Your advise is appreciated.

[Nick G]

The cost of a consultation with an accountant is a drop in the bucket in this scenario. You or they need to go through everything, including how assets will be handed down to the next generation and when, what leisure activities and costs are in the frame, cash reserves, other expenses and insurances, other assets etc etc.

[artemis]

Recommend they start by reading Matthew Gilligan's Tax Structures 101, possibly also his Property 101. Use the info to make a list of questions and issues to discuss with the professionals.

[Perry]

Agree with the preceding comments, adding that Nick's comments about (what might be called) estate planning is very important. E.g. if a Trust is used, the Trustees need to be a generation younger and the way in which they (and successors) are appointed [pursuant to the Trust Deed] is important. If the Trust Deed does not say so, I understand that appointing a replacement Trustee by Will is not allowed.

[Rosco]

Hi Chrisgoh,

There is no set answer. Everyone is different. Also how the properties are currently owned could affect the advice.

Trust - you are mainly looking at asset protection. As retiree's they probably have very little risk. BUT, passing their assets onto the next generation in a certain way might be very important.
A Trust also gives flexibility with allocating income. So could allocate some income to grandkids for example, at possibly no or low tax.

LTC - Wouldn't put personal house in here, but could put rentals, and then have LTC owned by Trust. Profits then flow to Trust.
Separates personal house and trust in a worst case scenario, ie landlord (LTC) liable for health and safety disaster.

Partnership - in some cases this could be fine, especially if all rentals already owned in this structure, and all income will go to retirees.
Profit would be 50/50 unless partnership agreement. So no real flexibility
Have to think through consequences and costs at death. So a Trust could reduce these costs. Ie if one partner dies in June, financial statements 1) from april to June for partnership, then finanical statements 2) from June to probate, say January between surviving partner and estate, then financial statements 3) partnership between surviving partner and where ever assets went in will. So 3 sets of financial statements, advice and tax returns can be quite expensive!

If using a partnership or personal ownership, could form Trusts upon death.

Sole Trader - likely to be not tax effective.

Normal company - taxed at 28%. If all profit wants to go to shareholders, how do you justify a shareholder salary if they don't work (ie have property managers etc). Or worse still if one party does all the work. Plus how do you get capital gains out? As you probably gather I generally don't like normal companies.

Hope this helps a little

Ross

[chrisgoh]

Thanks all for the advise, much appreciated.

Ross, gathered from your brief overview relating to the couple scenario:

1. Trust - Good for asset protection. Since the couple are retirees, the risk is low. So Trust may not be top of the list. However, it has the advantage of allocating income to the beneficiaries. Are all the incomes from the Trust required to be distributed to the beneficiaries? If not, will the undistributed income sitting in the Trust be taxed (what rate?)? If overtime, the Trust accumulated substantial cash reserve, can the Trustees decide to buy more rental property?

2. LTC - Good for negative gearing rental properties because the 'loss' can be used to offset personal income. Since the rental properties are mortgage free and the retirees are jobless, LTC may not work for the couple? If the new government remove the negative gearing tax advantage, LTC becomes obsolete?

3. Partnership - Main concern is cost of death due to high admin cost and other consequences. Other than that, it works fine for the couple?

4. Normal company - Tax rate 28%. Difficult to justify shareholder salary. How about distribute profit as dividend to the shareholders on quarterly basis? Will shareholder salary and dividend be taxed again at personal level?

5. Sole Trader - Not keen

6. Personal ownership (co-owners) - Risk can be mitigated by insurance? Form Trust upon death seems to be a simpler and workable solution for the retired couple?

At some point in time (probably Jan 2018 ), will keep in touch with you to go into details.

Thanks!

[Rosco]

1) Trust generally has discretion. So can allocate to one beneficiary, or to multiple, or to none. Can distribute all income, some or none. Retained profits taxed at 33%. Trust normally can buy more rentals.

2)You might want to read my points on LTC again. Can work very well for profit too, especially if owned by a Trust.

LTC are great for flexibility, with profit or loss. So if can no longer offset losses against personal income, there is still likely to be a place for LTC's.

4) Dividends take time and effort to prepare. If you use an accounting firm, quarterly dividends would be very expensive. LTC could be much cheaper and easier!

Yes shareholder salary or dividends then become personal income, so taxed again at personal level less any tax paid in company (for dividends)

6) Often co-owners is really a partnership.

Ross

[chrisgoh]

Got it Ross.

Will arrange to meet with you, thanks.

[King13]

A couple of points & questions.

- What is the benefit of LTC owned by the Trust? The LTC would pay tax at the company rate but wouldn't income passed to the Trust be taxable at the Trust rate?

- There can be substantial costs in moving the rentals from current ownership to any new structure. As is advised, structure should be set in place before buying the investments.

[Perry]

A couple of points & questions . . . but wouldn't income passed to the Trust be taxable at the Trust rate?

Only if retained in the Trust. If distributed to a beneficiary, the answer is no.

[Anthonyacat]

- What is the benefit of LTC owned by the Trust? The LTC would pay tax at the company rate but wouldn't income passed to the Trust be taxable at the Trust rate?
- There can be substantial costs in moving the rentals from current ownership to any new structure. As is advised, structure should be set in place before buying the investments.

LTCs don't pay tax at any rate, profits or losses flow directly through to the underlying shareholders, except when loss limitation (complex and annoying) applies.

In many cases there'd be little benefit in having it in an LTC versus having it owned directly by a trust. But if it's already in an LTC, it's a lot easier to transfer the LTC shares to the trust than it is to sell all the property from LTC to trust.

[Rosco]

There can be very good reasons for having an LTC with rentals, owned by a Trust. Rather than rentals directly in a Trust.

As mentioned earlier in this thread and in bold below! A key part of structures is separating risk. In the past rental properties had virtually no risk, but times are changing. Now if you had 10 rentals, you wouldn't want them in the same entity as your personal house. Health and Safety for example is a real risk to property investors.

Another reason might be for ease of Trust administration.

Another might be to keep GST separate to your Trust. If you had a commercial property, you might not want to GST register your Trust (can have unintended consequences later if rent as short term accommodation at some stage, or have a holiday home)

Ross

LTC - Wouldn't put personal house in here, but could put rentals, and then have LTC owned by Trust. Profits then flow to Trust.
Separates personal house and trust in a worst case scenario, ie landlord (LTC) liable for health and safety disaster.

[chrisgoh]

LTC - Wouldn't put personal house in here, but could put rentals, and then have LTC owned by Trust. Profits then flow to Trust.
Separates personal house and trust in a worst case scenario, ie landlord (LTC) liable for health and safety disaster.

The main advantage I see in your explanation on LTC owned by Trust is risk management. Assuming the tenant sue the landlord for whatever reason, the rental involved will have limited liability since it is parked under LTC and owned by the Trust. That means the personal house of the trustee or beneficiary are protected, but the LTC that owned the rental is liable. Technically, the shareholder of LTC is the Trust (legal entity) instead of the trustees and beneficiaries. Hope I got it right.

[Rosco]

GST can also be a biggie, in certain cases.

As can ease of Trust management. Much easier to run a Trust that just owns a personal house and some shares in an LTC.

Ross

[Perry]

I wonder about all that - in case of a relationship break-up.