I’ve bought an investment property, now what do I do?
An excellent question! The first thing to work out is how you own it, and there are a number of options for you to consider.
Funnily enough, how you own property has the same level of importance as deciding how to build a house – whether or not you work everything out today, sooner or later you will have to work it out. And just as doing structural renovations to an existing house is more expensive than if you’d done it at the beginning, so too it is with structuring the ownership of your investment property – it’s always more expensive later.
Consider also the ‘Choices Principle’ – if you choose to set yourself up in a tax advantageous situation from day one, IRD cannot question why you chose a particular structure. However, if you want to change the structure mid stream, you must have a good commercial reason and if IRD don’t think it’s a good enough reason, they will tax you as if the change never took place.
In this article, we consider the main options available. Firstly, you can own the property in your own name as a sole trader. This is the cheapest option because nothing else is required as long as you have an IRD number. However, it potentially has a large fish hook in that as a sole trader there is no asset protection and your liability to creditors is unlimited. On a practical level, this means that any other assets you own in your personal name, even if they have nothing to do with your business, will carry the same risk as your business.
The second option is to own the property with someone else, that is, in a partnership. Again, this is a relatively cheap option, however it potentially has an even bigger fish hook compared to a sole trader because of a condition called ‘joint and several liability’. Even if you don’t know what your business partner or partners are doing you will carry the same level of liability, and that liability is not shared equally – it will be carried by whoever can pay the creditors.
The third option is to set up a company and have an ownership vehicle that sits separate from you. The company will have directors (who manage the company) and shareholders (who own the company). This is a great way to separate your property business from the rest of your life. As we have a separate entity to yourself, liability is now contained within that entity, thereby providing a greater level of protection to your other assets.
An often talked about option is that of a Look Through Company or LTC for short. An LTC is, for legal purposes, a company but for tax purposes any profits or losses (assuming certain criteria are met) flow through to the shareholders. The profits or losses are added or deducted to whatever other income the shareholder has, and the final tax bill is calculated on this total.
The final option discussed here (but not the last option) is that of a trust. Like a company or LTC, it sits separate from you. A trust has three parties – the settlor (person who sets up the trust and chooses the trustees), trustee/s (those people charged with looking after the assets of the trust for the beneficiaries) and beneficiaries (those people who will ultimately benefit from the trust). The most expensive option discussed here, a trust is not a legal entity and is often misunderstood in this way. While the accounting cost is much the same as a company or an LTC, trusts do have a larger administrative requirement, and as such should only be used if you’re prepared to adhere to the administrative requirements.
In working out which is the best option for you, there are many issues to be considered, not least of which is where you plan to be on a long term basis with your property investing and what time frame you are investing for. Talking to someone with expertise in this area is the best way to work out what the best option is for you and your particular circumstances.