Structuring
Trusts, Companies, LTCs – all you want to know and more!
What's so great about LTCs?
The Look-Through Company (LTC) is an ordinary New Zealand company which has elected into the LTC tax regime, thereby becoming transparent for tax purposes with income and losses flowing through to owners in proportion to their shareholding.
This is a very common property investment structure in New Zealand. Recent tax law changes such as the Bright Line Test and Residential Loss Ringfencing have reduced the benefits somewhat, but it is still a great structure worthy of consideration for 80-90% of investors.
Benefits of an LTC as a property investment structure:
Utilising Equity in the Private Home
Note that due to the pending legislation announced March 2021 removing interest deductibility on residential rental property (more info here, here and here in the Publications section), this benefit is now not relevant to older properties – defined as those which received their CCC prior to 27 March 2020.
In the case where a private home is becoming a rental property, an structure change is usually necessary and an LTC is almost always the best option. Selling the home to an LTC allows the company to refinance the mortgage to release equity to the shareholders, who can then use this to buy their next owner occupied home. If this were to be done without a restructure, none of the new debt would be deductible, but via an LTC this potentially saves thousands a year in tax.
Shareholding Structure
Can set share ownership structure to stream income to the lower earner, optimising lower tax brackets.
Can set share ownership structure to stream non-residential losses to the higher earner, generating optimised tax refunds.
Can change share ownership structure at a later date when situations change (though be careful – this may have deemed-disposal Bright Line implications).
In the event that a trust is created later on, can sell all the shares to the Trust instead of selling the individual properties – saving many thousands in legal fees for moderate property portfolios.
Simpler/Better Tax Treatment of Borrowing
When a rental property is owned in private names, and the mortgage is paid down over years of contributions from private income, the tax deductibility of that debt is gone forever – if later redrawn for private purposes this new debt is not claimable for tax purposes. If that rental were owned in an LTC, reborrowing for the purposes of repaying the shareholder loan is claimable for tax purposes – what the funds are spent on are of no relevance.
When a flexible overdraft facility is part of the mortgage, every time funds are withdrawn creates a new lending event for tax purposes. Depositing a salary into this overdraft pays down deductible rental debt. Drawing some back for your credit card bill is considered new borrowing for private purposes – your deductible loan drops over time. If the rental is in an LTC, the drawing can be considered repayment of the shareholder loan, and remains deductible.
Limitation of Risk
While the risk of legal exposure as a result of property investment is fairly small, owning investments in a company reduces this even further. In the event that the property owner is subject to a large and successful lawsuit (for example, a significant health and safety breach) the company may become insolvent and investments lost, but the shareholders’ private assets should be protected.When a rental property is owned in private names, and the mortgage is paid down over years of contributions from private income, the tax deductibility of that
Simplification of Structure
This seems counterintuitive, but in some instances adding an LTC to your structure simplifies it overall. If your rental purchases are made in your own name, and then at a later date you decide to convert your own home to a rental, there are strong reasons to incorporate an LTC to restructure this (as explained in #1, above). At this point, you would have several rentals in your own name which due to Bright Line you may not be able to restructure for several years, and an LTC with a single rental in it. This is unnecessary complexity to add to your structure, and could be avoided by using an LTC from the start.
Low Cost
Setting up an LTC yourself currently costs less than $200. As a client I can guide you through this to avoid making any mistakes, free of charge. Annual costs of company operation are only around $50 for the companies office filing fee, and a small increase to annual accounting fees, $125 as at the time of writing. In comparison to a Trust which will cost on average $1,500-2,000 to set up and $500-800 per year in ongoing costs, it’s a clear bargain.
Get in touch to discuss whether an LTC is right for you
Do I really need a trust?
Probably Not. That is – unless you do.
If it seems like all your friends have a Trust, you’re not alone. By some estimates, New Zealand has up to half a million trusts. They’re pretty common. But many or even most could be unnecessary.
Trust in the Past…
Historically, trusts were extremely efficient tax vehicles. Commonly seen as a way of getting around Estate and Gift taxes (abolished in 1993 and 2011 respectively). Income Tax benefits came to the fore from 2000 to 2010 when the top personal tax rate was set at 39% but the Trust rate remained at 33%. This particular benefit may return with Labour’s pledge to reintroduce the 39% tax bracket but no mention of changing trusts.
Once upon a time, trusts could distribute swathes of income to children, creating massive tax benefits for those with one or more young kids. But not anymore. Children age 15 and under are now limited to just $1,000 per year per child (per trust), thanks to the Taxation (Beneficiary Income of Minors, Services-Related Payments and Remedial Matters) Act 200.
Vesting assets in a trust over a long period of time was also a commonly used method to access the Residential Care Subsidy where one would otherwise not qualify due to exceeding the set wealth thresholds. As at the time of writing this remains a possibility, but expect government attention to pass over and review this at some point in the near future.
Trust in the Future…
Looking forward, a trust still has a modicum of tax benefits, The aforementioned $1,000 distribution per child saves a top earner just over $200 in tax per year. For families with non-working children over 16 , a low-income partner, or dependent retired parents the benefits are much higher.
The main reason to consider a trust is asset protection. Should you personally be found liable for a significant legal settlement, a well run trust can help keep significant assets safe.
The downside is the cost. Trusts require expert legal advice to set up, which comes at at significant cost; often $2,000 – $4,000. In order to best ensure compliance with the various trust rules and regulations it is recommended that a Professional Trustee is appointed which commonly comes at a cost of $750 – $1,500 per year.
Get in touch to discuss whether a trust is right for you.
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