This is a big question. The answer is going to depend on a range of factors, but there are some general rules you can apply.
If the property is likely to be ‘negatively geared‘ (i.e. it is going to make a loss to start with), then the owner should be someone who earns other income against which this loss can be offset, i.e. the highest income earner. If you are a couple, then ideally the property is owned by the partner earning the highest income.
On the other hand, if the property is ‘positively geared‘ (i.e. the income generated by the property exceeds its costs), then ideally the owner is someone who is on a low marginal rate of tax, i.e. the lowest income earner. This is because the rental income will then be subject to lower rates of tax. If the property is owned by a high income earner, the additional rental income just bumps you up to yet higher rates of tax.
The problem is, properties often start out as negatively geared and then become positively geared…
So, what many people do is first acquire a negatively geared property in a high-income earner’s name, and when the property becomes positively geared, they buy another negatively geared property to once again offset the income. Over time you end up building a larger property portfolio, which overall pays for itself and is slightly negatively or positively geared. Ideally, you end up with a solid income stream that enables you to buy more and more properties – and ultimately retire!
Property is a long term investment and your income level, and that of your partner may vary wildly over time. You may lose your job, get a promotion, take time off work to have kids, etc. This can play havoc with your property investment strategy.
One option to try and manage this is to introduce a discretionary family trust into the mix. This will definitely complicate your life, but may just be worthwhile. If you would like to get a better understanding of how discretionary trusts work, read this article.
When a property is held in a discretionary trust you get to choose who receives the net income each year. So one year you can distribute the rental income to person A, and the next year to person B. If person A is working and person B is at home, then all of the net income would be directed to person B who will be paying tax at a lower rate. If things change down the track, and person B starts to earn more income than person A, you would then direct the net income to person A.
This all sounds great, but there are some catches.
First, it may be harder to get a loan to buy a property in a discretionary trust. You need to discuss this with your bank or mortgage broker. That said, most banks these days understand and can accommodate a discretionary trust as the borrower.
You also need to be careful if the property is going to be negatively geared for a period of time. If the property is in a trust and makes a net loss (taking into account all possible tax deductions, including depreciation and capital allowances) then the loss gets ‘stuck’ in the trust. You can’t offset this loss against your salary and wages. The loss gets carried forward in the trust and can be offset against future income, but that’s it. (This also assumes you have made a family trust election, but that’s another story…)
If your property is positively geared from the outset or is likely to be positively geared within a reasonable period of time (e.g. if you have a big deposit or if it’s listed on AirBnB or is a commercial property), then holding it in a trust can be a good strategy. This is also the case if you already have other income coming into the trust, for example from a business or other investments. Once you have other net positive income in your trust, you can then start to introduce negatively geared property (or other investments) to offset against the net income. You can then build up your property portfolio within the trust over time, just like you could in your own name.
Another thing to consider is the impost of land tax. Some states will impose a higher level of land tax on properties held in trust.
There are many pros and cons associated with using trusts to build your property portfolio, and you will need good advice to make sure you stay on the right side.
Call us on 1300 654 590 for a no obligation chat about the best way to hold your investments.