Structure is important when starting out investing in commercial property.
Getting it wrong can have long-term tax and asset protection implications that can be costly.
But getting the structure right creates a foundation for long-term maximum returns.
Understanding your tax obligations as an investor
Generally speaking, commercial investors pay tax on the net rental income they earn from an investment property, plus tax on any profits they make from the sale of that property.
However, the government offers commercial property investors numerous discounts, deductions and exemptions to encourage investment. The way that the tax is calculated depends on the type of entity that owns the property.
The great thing about investment property is that you can claim tax deductions for most expenses incurred while it’s operating, including:
- interest paid on a loan used to buy the commercial investment property
- travel costs incurred during visits to the commercial property
- advertising fees
- repair, maintenance, and management expenses
- depreciation of the building structure and the assets within it.
While each ownership structure is obliged to pay a different rate of tax, each structure can also claim different types of deductions.
In addition to the deductions mentioned above, each ownership structure is often entitled to claim a credit for the GST included in the purchase price, as well as the following discounts and deductions.
Buying an investment property as an individual
If you are the legally recognised owner of the commercial property, the rental income is incorporated into your assessable income and taxed at the individual’s marginal tax rate.
It’s similar for properties with multiple owners. The proportion of rental income attributed to each owner is equal to the size of their legal interest in the property – regardless of any agreements between the owners that state otherwise – and each portion of the rental income is taxed at the rates that apply to each individual owner.
As with residential property, individuals must also pay tax on any capital gains made from the sale of a commercial investment property. The capital gain is added to the individual’s assessable income.
Owners will also add goods and services tax (GST) on the sale price if the going concern assumption isn’t satisfied. The going concern assumption basically means that both the buyer and the seller are registered for GST, that there is a current lease in place on the property, and that everything necessary is being done to support the continued operation of the business.
This means they pay GST on one-eleventh of the sale price and claim GST credits on purchases that relate to selling the property.
But there are exceptions, for example when you use the margin scheme to work out the GST on the sale of commercial premises or sell the property as part of a GST-free sale of a going concern. If you own the commercial property through a company, you’re liable for 30% tax to be paid on the property’s net rental income.
This is the same as the current corporate tax rate and is often a lot lower than an individual’s marginal tax rate. The highest tax rate sits at 45% alongside a Medicare levy of 2% (for FY2018-19).
Capital gains are also taxed at 30%, unless the company is eligible for one of the four small business capital gains tax concessions offered by the ATO. Like individuals and trusts, companies must also pay GST on one-eleventh of a commercial property’s sale price if the going concern assumption isn’t satisfied, but they can claim a few GST credits on purchases that relate to selling the property.
Buying property through a discretionary trust
You can also choose to purchase your commercial property through a discretionary trust. This means the trustee can apportion the rental income from the trust’s property to the beneficiaries however they like, on a discretionary basis. The bonus is that you can get smart about tax.
You, or the trustee, can apportion the most rental income to the beneficiary with the lowest marginal tax rate. The beauty of this is that only the beneficiaries who receive an income pay tax; the trust itself doesn’t pay any tax as it is a flow-through entity.
However, the trust must pay GST on one-eleventh of the sale price if the going concern assumption can’t be satisfied, but it can claim GST credits.
This is a no go when it comes to negative gearing, though. A discretionary trust can only distribute income to beneficiaries, not losses. But capital losses can be carried forward and offset against future capital gains. And beneficiaries that receive capital gains can apply whatever discount their specific ownership structure entitles them to.
Investment property and land tax thresholds
Land tax thresholds also need to be considered when using a discretionary trust to purchase properties.
Some states, such as NSW, don’t allow any land tax threshold for property owned through a discretionary trust.
Fixed or land tax unit trusts can be used in this instance to obtain the land tax threshold; however, these types of trusts don’t offer discretionary distribution to beneficiaries. Distributions need to be made in line with the unit entitlement.
Working out the best ownership structure for a property well before you purchase an asset is imperative.
The costs of unravelling an incorrect structure can be enormous. Double stamp duty is an implication of restructuring. By minimising your tax obligations and setting up your finances appropriately, depending on your goals, you can safeguard your investment and your wealth.
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