An investor recently asked me, ‘Should I buy an investment property in my own name, my company name or via my super fund to maximise depreciation?’
While the tax implications are a very important part of your property investment strategy, I would never make taxation the number one reason for determining how I structure my investments.
There are many other reasons people make property investment decisions, such as for security reasons or to minimise land tax. In answering the question, I explained the basic premise that depreciation of property reduces the taxable income of the entity that holds the property. So the tax rate for that entity, when the rent is included in the equation, decides the depreciation benefit you gain.
Let me illustrate this with these scenarios:
Buying property through your SMSF
Super fund name: Washington Brown Super Fund
Washington Brown Super Fund is a complying superannuation fund and therefore its earnings are taxed at 15 per cent.
Assuming the depreciation report calculates depreciation in Year 1 at $10,000, then the maximum tax benefit to the fund is $10,000 × 15 per cent = $1,500.
The 2017 Budget will treat SMSFs the same way as individuals in the future, i.e. they will no longer be able to claim depreciation on previously used assets, only on the building write off allowance for second-hand residential property.
Buying property in your own name as an individual
Personal name: Tyron Hyde
For the purposes of this example, I am on the highest marginal tax rate and I pay tax at 45 per cent.
Assuming the property depreciation report calculates depreciation in Year 1 at $10,000, the maximum tax benefit to me is $10,000 × 45 per cent = $4,500.
Buying property through a family trust
Property trust name: Washington Brown Trust Fund
A trust is not taxed on its earnings, but rather when it pays a distribution. Those who receive the distribution are taxed at their own marginal rates.
So, assuming a depreciation report calculates depreciation in Year 1 at $10,000, the maximum tax benefit to the trust is $10,000 × 0 per cent = $0.
After the 2017 Budget, discretionary and family trusts will be treated the same way as individuals in the future, i.e. they will no longer be able to claim depreciation on previously used assets. They will only be able to claim on the capital works deduction allowance for second-hand residential property.
Buying through a company
Company name: Washington Brown Pty Ltd
The company tax rate varies from 28.5 per cent to 30 per cent, depending on the size of the business, but let’s assume 30 per cent for ease of calculation. The depreciation report calculates depreciation in Year 1 at $10,000, therefore, the maximum tax benefit is $10,000 × 30 per cent = $3,000.
But wait, there’s more…
In the scenario above, where the trust fund is the holding entity, I have assumed the property is the only asset held in the trust. If the only income the trust receives is the rent on that property, then the depreciation benefit is nil.
However, more often than not, a trust has other investments and may receive distributions that make depreciation beneficial.
If the property is in a trust and it is negatively geared, then the depreciation will increase those losses. But losses in a trust cannot be distributed and therefore are quarantined in the trust until those losses can be offset by other revenue.
In our examples, the super fund receives the lowest amount of depreciation deductions (if you exclude the trust) so you could argue that it is not the best structure. However, all earnings in the SMSF are taxed at the maximum rate of 15 per cent, and when the fund is in pension mode, the earnings and capital gains can be tax-free, which can be compelling reasons to structure your investment in this way.
Each individual investor must look at their own set of circumstances before deciding in what name to purchase a property. Taxation is one consideration and depreciation allowances are one part of the taxation puzzle. An in-depth review of taxation on property investments is beyond the scope of this book. Personally, I have purchased property in my own name, my super fund and in a trust – all for varying reasons.
I always seek financial advice from my accountant or financial adviser before entering a contract and you should too. That way I know the entity that ends up holding the asset is the right one from the beginning. Changing the structure of your investments can be a difficult and costly exercise.
The 2017 Budget outlined that companies are exempt from the budget changes, which will make companies more attractive as a vehicle to acquire property in certain circumstances.