Trust vs LTC for residential investment property – which is better?
Well, it depends if the property is negatively or positively geared, i.e., does it make a loss or a profit. Let's deal with negative gearing first.
LTCs allow profits and/or losses to flow through to the shareholders; Trusts don't allow losses to flow through to the Beneficiaries (only profits).
Trusts are taxed at a much higher rate than companies (33c/$ for trusts vs 28c/$ for companies), and if there are any losses from your rental investment property, you can’t use them to offset your income. Why do we say that? The IRD says: “If a trust suffers a tax loss that loss can not be passed to beneficiaries to offset against their income, except in limited circumstances. Generally, a trust will have a loss for tax purposes if their income is less than the expenses incurred to earn that income.” (See here for the full text).
Therefore, our recommendation would be always to form a Look Through Company to own and administer your residential investment property. (See here to find out why an LTC is better than using a partnership to buy a rental property)
If a property is positively geared the main question is:
Here's why: If you are in or near the top tax bracket (>$70,000 per year), then you will be paying 33c/$ for all income over this amount. Any extra income received from the rental property will be taxed at this, the highest tax rate. Therefore, in this scenario, there are three options:
You can, of course, setup an LTC and have a Trust owning a look through interest, but we can't really see the point of that, apart from asset protection advantages. That being said, the bank will usually require the universal guarantee of the Trustees, which makes the whole "asset protection" somewhat of a moot point in our opinion.
The only downside of option 3 is this: if you want to draw funds out of the company to drive down the mortgage on your own personal dwelling, then this will be viewed as personal income for you, and you'll have to pay tax on it. Note that this would, of course, reduce the tax that the company has to pay.
9 times out of 10 the best structure for owning your rental property is going to be an LTC. The most common structure we see is this: The purchasers of the rental property have their personal homes in a Trust (for asset protection) and have their residential rental property owned by an LTC. (For a short video on the merits of using an LTC to own your rental property, see here).
It is our view that you need to look at getting the best use out of the legal structures in place, and to consider what their purpose is. For this reason, we would recommend that before implementing any sort of Trust, you get some good legal advice from a solicitor with experience in residential investment property. We would also recommend that you do some serious homework on the investment side, ideally consulting with an AFA (we recommend Goodlife Advice). And, obviously, talk to a property accountant.
For further reading, have a look at this link on the IRD website
* Obviously, if the partner/spouse is earning $48,001 or more per annum, this option would not be recommended, as the income will be taxed at at least 30c/$. In this scenario, option 3 would be better.
Accounting for your rental residential investment property; general taxation advice.