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Tax tips: Investing in property in the wrong name could cost you money
By Ed Chan
Tuesday, 24 April 2012
Many people who have invested in property may have purchased the property in the wrong name, and the cost to correct it creates a stamp duty and capital gains tax liability and thus prohibits the property from being moved.
Why would people buy properties in their own names?
The main reason is for tax.
Generally if the property is negatively geared, then having it in the name of the person paying the highest tax means that he/she gets back the largest tax refund from the ATO. However, if that person’s occupation exposes him/her to litigation, such as a doctor or someone running a business or a director of a company, then holding assets in their his or her own name would be a silly thing to do.
If someone sued him/her than any assets that are in his/her own name are up for grabs.
Australia only trails the US for being one of the most litigious countries in the world. Last year a mother of three in the US was sued by a music company for illegally downloading 12 songs from the internet. The judge found in favour of the music company and ordered damages of $100,000 per song. Unable to pay the total damages bill of $1.2 million plus costs she lost her home and any other assets she held in her name.
Properties that have been bought in one’s name can be protected without needing to move them using several different strategies.
The principle behind this asset protection strategy is to protect the equity in the properties. Litigants are not interested in the property itself, but they are interested in the equity. Thus protecting the equity is more important than protecting the asset itself.
1. You can strip any equity that is left within the “at risk” property by asking the bank to take 100% of the equity of the “at-risk” properties for their security and leaving properties that are not “at risk”.
2. Properties that are not “at risk” are those that are held in a property investor’s trust (PIT) or those held in a “not at risk” spouse’s name. However, be careful that you have considered the tax benefits that may be lost if the property is negatively geared and your spouse earns and pays less tax than you do.
3. If you are unable to adopt the above strategy than you can use an “equity bank trust” that will strip the equity from your “at-risk” assets. This is a relatively low-cost solution but a very effective strategy.
4. Naturally the best solution is to ensure that the properties are purchased in the correct entity to begin with. Having the property in an entity such as the PIT deed that has an ATO approved product ruling (Product Ruling PR2011/15) is better than trying to fix the problem later. The PIT allows you to claim the negative gearing in your own hands (as long as it’s set up correctly) and protects the property from litigation. The PIT does not have a vesting date, so the assets can be passed from generation to generation.
5. If both husband and wife are in high-risk occupations they should not have their homes in their own names in case they are sued. However, the problem with holding the home in a trust is that one loses one’s principal place of residence tax free status for both land tax and capital gains tax. Depending on where you live (in which state or territory), one can hold the property in a PIT and grant a life interest to the individual to retain his or her land tax-free status and capital gains tax-free status. However, you must seek advice, because if not set up properly this strategy could potentially backfire. It would also be a good idea to get a private ruling to ensure that this will work in your particular circumstances.
6. If you have loaned money to your daughter or son to purchase a property with, make sure that you have either registered a second mortgage or a caveat over the property in case his or her marriage and or de facto relationship fails. The second mortgage/caveat ensures that you at least get back the loan or gift you had given your son or daughter.
Ed Chan is a founding partner of Chan and Naylor accountants and a leading property tax specialist. He has co-authored three best-selling books as a seasoned property investor who understands the relationship between property investment and tax.
