TRUST VS LTC FOR RESIDENTIAL INVESTMENT PROPERTY
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.”
However, our recommendation would depend on the circumstances, your financial plan, the gearing of a property and the incomes of each owner (if more than one).*
If a property is positively geared the main question is:
- What tax bracket are the purchasers in?
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 main options:
- Setup an LTC to own the rental property, with the majority shareholder being your spouse or partner who is on a lower tax bracket (if applicable). Ideally they are earning no more than $35-$38k per year (to allow for $10-$13k income per annum from the rental). Thus the income is taxed at 17.5c/$.**
- Setup a Trust to own the rental property. Again, if there is a spouse/partner on a lower tax bracket as above, then the Trustees can distribute the income to this person, who will then be taxed at personal tax rates.*
- Setup an ordinary company to own the rental property, and pay tax at 28c/$ on the profits.
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.
Often (but not always) 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 more info 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 a qualified Financial Advisor (we recommend Goodlife Advice). And, obviously, talk to a property accountant such as ourselves.
For further reading, have a look at this link on the IRD website
* See here to find out why an LTC is sometimes better than using a partnership to buy a rental property
** 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.
My wife & I are New Zealanders who live overseas. We have lived away from NZ for over 28 years. We come to NZ for a few months each year and are not NZ tax resident. We are interested in buying rental property in the Auckland. Your article LTC vs Trusts was most interesting.
(1) we create a LTC
(2) If we purchased a rental property under that LTC, that generated a loss for the 1st 5 years and we remained living overseas and were not a NZ tax residence
Questions: would the losses incurred over the 1st five years,
(1) be allowed by the IRD, to accumulate under the LTC
(2) be allowed to be set-off against our future income (i.e. NZ$200,000 p.a.) assuming that in 5 years time we return back to NZ to retire & draw upon our pension and other investment incomes” Tony Short