BEST RENTAL PROPERTY OWNERSHIP STRUCTURE

Sep 20, 2023

BEST RENTAL PROPERTY OWNERSHIP STRUCTURE

Which is the best rental property ownership structure?  Although not exhaustive, we hope that this article will give you an overview of the four most commonly-used structures and their pros and cons. Many clients ask us “what’s the best structure for my investment property?” We set out here to outline some of the pros and cons.

LTC/ LOOK-THROUGH COMPANY

LTCs or Look-Through Companies have been regularly used in recent years for ownership of rental investment property. All income or loss is distributed based on shareholdings. For example, if the LTC makes a profit of $1,000, and Bob and Mary have 50 shares each (of 100 total shares), then Bob will declare $500 income on his personal tax return and Mary the same amount on hers. The LTC declares and pays no income tax.

The same thing happens if the LTC makes a loss. In other words, if the LTC makes a loss of $1,000 (because expenses were more than income), and Bob and Mary have 50 shares each (of 100 total shares), then Bob will declare $500 loss on his personal tax return and Mary the same amount on hers. The LTC declares and pays no income tax.

Note however, that losses from rental residential property have been ring-fenced since 2020 financial year. What that means is that the loss can’t be offset against your wages or other non-rental income. It can only be offset against other rental residential income. Excess losses are carried forward to the following financial year.

Can the distributions be changed in an LTC? Yes, but you have to change the shareholdings, and this will often trigger a reset of Brightline Rules for the shares that are transferred. Also, there can be tax implications if you transfer too many shares, and you open yourself up to accusations of tax avoidance. For a more detailed consideration, please see this article

COMPANY

Standard companies can distribute profits to shareholders but not losses. This means that:

  1. if you are in the top tax brackets*, and
  2. your rental property runs at a profit

then, the use of a standard limited liability company could be the best rental property ownership structure for you.

Why? Profits are taxed at a flat 28c/$, which could save you anywhere from 2%-11% tax on your rental property income.

However, if your rental property runs at a loss (expenses exceed income) and looks like it will stay that way, then this is likely not the right structure. This is because those losses will most likely be trapped in the company, and cannot be offset against rental income that is earned in personal name or in another entity. Excess losses are carried forward to the following financial year.

Note that the same comments about changing shares in LTCs applies to standard limited liability companies.

TRUST

Like standard companies, trusts also can distribute profits (to beneficiaries) but not losses. This means that

  1. if you are in the top tax brackets*, and
  2. your rental property runs at a profit

then, the use of a trust could be the best rental property ownership structure for you.

Why? Profits are taxed at a flat 33c/$, which could save you 6% tax on your rental property income (if you are caught by the top tax bracket of 39%/$). Note that the trust tax rate will increase to 39% during 2024.

Now you may be asking: why wouldn’t I use a standard company? It is taxed at the lower 28% flat rate. This is a good question. Often times, this may be for asset protection. Or it may be that the income in the trust can be distributed to beneficiaries, and you can take advantage of their lower personal tax rates. Trustees have vast power to distribute as they see fit, whereas payments from companies to shareholders are bound by much stricter rules.

Please note though, that if your rental property runs at a loss (expenses exceed income) and looks like it will stay that way, then this is likely not the right structure. Why? For the same reasons as a standard company: Those losses will most likely be trapped in the trust, and cannot be offset against rental income that is earned in personal name or in another entity. Excess losses are carried forward to the following financial year.

PARTNERSHIP

A partnership is a group of 2 or more people or entities. If a partnership has only 2-3 parties, then an IRD number may not be needed

A partnership is very similar to a LTC in its ability to distribute income and losses. The difference is that instead of the distribution being dictated by the number of shares, it is dictated by the % held as defined on the property title (in the case of property) or by the terms of the partnership agreement.

The distribution can be changed by changing the % ownership on the title, but there would be tax and legal implications and the wording of any partnership agreement would need to be considered. Here too though, you must be careful that distributions are not done purely for tax reasons, as this leaves you open to accusations of tax avoidance.

Note that if there is no agreement, then the profits or losses must always be distributed evenly.

FURTHER READING & HELP

For advice on your situation, please contact us today.

You might also wish to read our other articles which discuss these in more depth, such as

Contact our experienced team on 0800 890 132 or click the button below to contact us.

*Top tax brackets: annual gross salary or wages of over 48k per year and thus taxed at 30% or more. See here for a list of NZ personal tax rates

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