SHOULD YOU FORM AN LTC TO OWN YOUR RENTAL INVESTMENT PROPERTY?
As a couple, should you form an LTC (Look-Through-Company) to own your rental investment property? There are two schools of thought on the subject, basically divided into “Yes, absolutely necessary” and “No, it’s a total waste of time.” What are the merits of the two approaches?
If you form an LTC, you have now another legal entity which has annual filing requirements with IRD and with the New Zealand Companies Office. In other words, more compliance costs. However, this legal vehicle does allow you to proportion losses (and income) according to the amount of shareholding that each shareholder has.
For example, John and Mary have an LTC which owns a rental investment property. Mary is not working at the moment (whereas John is), so they have chosen a shareholding percentage of 95/5 for Mary/John. This allows the income to flow disproportionately from the LTC to Mary, who is in a lower tax bracket.
Of course, any tax benefits are incidental. The main reason for planning things this way is that John is flat out at his job, whereas Mary (who works part-time) has a bit more time on her hands. Thus she does almost all of the work involved with the property. And therefore, she is appropriately remunerated for this, hence the 95% shareholding.
The beauty of the LTC is that it has been explicitly set up and clearly and legally allows losses/profits to flow through to the company owners.* The LTC has its own bank account, which expenses/income go through, leaving a nice neat audit trail to follow.
An income tax partnership can be used to own a rental investment property. In this scenario, each natural person is an owner of the property, and the partnership % of ownership as listed on the title is used to determine the share of each person in any losses/profits which flow from the investment property.* As no company has been created, compliance is a little less. However, filing with the IRD is still mandatory for each owner of the rental property and for the income tax partnership.
Where it can get confusing is that expenses are not forced into their own bank account. If the owners are not good at keeping their paperwork, you can end up with a real mess at financial year end, as well as an auditor’s nightmare.
All things being considered, our opinion is that “best practice” would be to form an LTC. It is more flexible, more transparent and more audit-friendly. However, if you already have rental properties in a partnership (or owned by a couple who are married, in a civil union or similar), then an LTC may not be the best option. Please contact us to talk over your options.
* From 1 April 2019, losses from partnerships or LTCs that are residential land rich cannot be used to offset the taxable income of the partner /shareholder. For more information on why this is, please see this article. And for help re structures and advice, please call us or email us.
Query from Reader
”I am married and plan to buy a rental property and still thinking of the ownership structure. WE currently have a Family trust and paid around $1,000 for it any we maintain it. We try to do things as much as possible by ourselves if we can and would try to avoid paying someone else’s services if we can or allowed to do so. My wife has some background in preparing income tax returns although not registered in New Zealand while I understand a few thing or two. I know the advantage of having the person with the higher income own more if not 100% of the property when it is making a loss and have the person with the lower income be responsible for the tax when the property is making a profit or at least most of it. However, bottomline is to get the best benefit in the long run profit wise which would include reducing all the unnecessary charges like paying for accountants or setting up unnecessary companies.
I was thinking of not setting up any company and by the property under our names which will be treated as a partnership and since we are married, we do not need a separate IRD. I assume we would initially make losses during the first year so I would own 99%. Is it true that when we start making profit, there is no way that my wife can later own 99% of it? How do we do this if we want to. Do we just reflect it straight on the return that my wife now owns 99%? Will the IRD question that? I am on the top tax bracket and she is on the bottom. You mentioned above about forming an LTC so I would not go through with the option here as I would like to avoid the fee of setting up one and the ongoing compliance cost as we would probably need to hire an accountant unless we can actually do it ourselves. Is that possible. Now what if we would only make a loss in the first year and start to make profit on the succeeding year, why not just put in in the family trust then and just offset the first year’s loss with the succeeding years profit and distribute the profit to my wife in the lower-income bracket. This would prevent the need to form an LTC right. IT could also result in not having the need to pay taxes earlier as well as if we offset the current losses to the next year’s profit then the next year may not have a profit yet so no tax needed to be paid. I guess even under the family trust, we can still claim all expenses we normally claim for investing in a rental property like the utility cost of having an office in your family home which would be a proportion of your family home expenses right?” Elliot
”Hi Elliot. I think the fact that you are asking all these questions seems to suggest that accountants may not be as “unnecessary” as you claim. Rather than attempt to spell out the pros and cons (and gotchas) of each scenario, it is probably better if you call us to discuss. Our number is 09 973 0706.” Garreth Collard