A more common term for a personal financial structure is a legal entity. We will use these two terms interchangeably throughout this article.
First-time investors don’t even think about personal financial structures; some seasoned investors often find it confusing. However, it’s essential to understand the options available and make an informed decision.
Why? Because it will affect the property’s ownership, the property taxes applicable to the purchase and sale, and even your available finances. Today, we want to help you choose a personal financial structure.
We will explore the options available to the savvy real estate investor in-depth and look at the advantages and disadvantages of each structure. Remember that you should seek advice from your accountant, solicitor, and mortgage broker to choose the right approach tailored to suit your financial goals and current situation.
This is the first article of a six-part series that aims to educate you on personal financing structures so that you can make informed decisions that are crucial to building a successful property investment portfolio. One of the most important things to remember going into this is that there is no one-size-fits-all personal financing structure. Individual circumstances differ, so you must choose what works best for you.
How do I Choose a Personal Financial Structure that’s right for me?
“Why should I consider a trust, company, or SMSF instead of buying an investment property?” is one of the most common questions asked in the real estate investment industry. Here are some of the most compelling factors to consider when searching for an answer to this strategically important question:
- Leverage: Capital is a limited resource, including from a borrowing perspective. How much you can borrow is dependent on the serviceability of a loan. Different types of structures open up the potential for an increased pool of capital. This opens up the potential for property investments that may not be available on your own.
- Compliance: Compliance is one of the costs involved when considering the right personal financial structure for a successful property investment journey, especially at the beginning.
- Setup Costs: Similarly to the issue of compliance, the setup costs need to be factored in when determining the Return on Investment (ROI) of a property investment.
- Asset Protection: If you are currently single, a personal financing structure will allow you to protect your assets when you enter a relationship. Additionally, the correct structure choice allows for the protection of inheritances and effective wealth transfer between generations.
- Property Taxes: A personal financing structure will provide optimum tax advantages, which are always welcome. Education on this topic also provides the property investor with an awareness of the disadvantages of each type of structure.
- Liquidity and Flexibility: Investing in real estate is a long game. Liquidity and flexibility are important factors to consider throughout the lifetime of your real estate investment journey.
- Wealth Transfer: Real estate investment is a long game, and the transfer of wealth is an important strategic factor to consider when one is setting themselves up for success.
Our next five articles will help you maximise the discussions with a professional by discussing these topics at length to choose the right personal financial structure required to begin your property investment journey. Our articles will help you understand the benefits a lot better and explain the law, which is constantly evolving.
Successful property investors know they need to surround themselves with a team of experts to help them formulate the perfect property investment strategy. Our articles on this topic aim to help you initiate these high-value conversations so that you can build the right team of experts to suit your circumstances and your property investment goals.
What types of Legal Entities are available to me?
Whether you are a seasoned property investor, or a beginner, trying to make a decision on your own can be overwhelming.
We break down the five most common personal financial structures available to the Australian real estate investor. Remember, no two investors are the same. We’re here to help you interview your dream team so that you can formulate your own property investment strategy. A successful strategy takes your personal circumstances and your aspirations into account. We’re here to help as many hard-working Australians as possible to build a successful property investment portfolio. Our goal is to help our readers attain financial freedom with maximum certainty in the shortest possible time, despite an ever-increasingly unpredictable and competitive world.
There are five common types of property investment structures that we will be discussing in depth in the coming weeks, with links to the relevant article as soon as they are published! Without further ado, let’s get started!
Individual Property Investment Structure
Going into property investment as an individual is the most common option, and it’s also the most inexpensive. Individual property investment structures may include buying the property with a partner or spouse. In that case, both names would be on the paperwork.
Buying a property on your own or with someone else facilitates the loan process, and it involves fewer fees. Additionally, the tax incentives may be attractive, and individuals may be eligible for a 50% CGT discount. Overall, it’s a good option for high-income earners.
The drawback of this personal financing structure is that your financial and legal duties won’t be limited or protected. You and your partner would be legally liable for your property. If you ever get sued, that may be a problem because your assets, including your property, will be exposed.
Overall, this personal financing structure can be a good option for high-income earners and first-timers who want to take advantage of negative gearing and don’t carry big risks.
Joint, Partnership, or Real Estate Investment Group Structures
Buying real estate with a group of people, whether it be with friends, partners or joining a diverse group of skilled experts, is a popular way to gain the first step on the property ladder.
Buying property in a group can be further classified into three types:
- Joint Property Investment Structure: investing in property together with your spouse/partner.
- Partnership Property Investment Structure: real estate investment amongst people in your network e.g., friends, family, and colleagues.
- Real Estate Investment Groups (REIGs): Investing with a group of property experts with diverse skills and experience.
While there are three types of investing in property as a group, they all share the same principles.
Similar to individual property investment, this personal financing structure suits first-time property investors. Group investing is especially appealing to those who want to take advantage of the pooling of available resources to target maximum ROI whilst carrying minimal risks.
Company Property Investment Structure
This personal financing structure allows you to get into property investment while limiting your legal and financial liability. Buying a property as a company allows you to enjoy a lower tax rate on rental income, and (to a certain degree) you’ll be protected from liability.
Using a company provides many benefits. The main one is that it limits your liability to the shareholders. That means that the shareholders will be liable for debts equal to the amount they invest as shared capital.
Another benefit is that creditors won’t be able to access shareholder assets. Additionally, once the investment is positively geared, the company will pay a corporate tax rate, which is lower.
One of the big drawbacks is that you won’t get the 50% CGT discount. Additionally, it can be challenging to secure capital, and any losses you have will be deducted from your future income.
Unlike the other options we have discussed so far, the company property investment structure requires setup and maintenance. This can be expensive to maintain, so it’s important to think the decision through.
This personal financing structure is best suited for individuals who make a high income and don’t want to pay high taxes. It’s also a good option if not being able to use the 50% CGT discount won’t be a concern for you.
Property Investment Trusts
Similar to companies, trusts are legal entities that are set up to manage the assets of beneficiaries. When set up correctly, it will limit your legal and financial liability, and also protect your assets. Trusts are expensive and a bit complex, but they offer great benefits.
The main reason why people consider trusts is that they have control over who benefits from the trust’s income. For example, when an investment becomes positively geared, it will be possible to distribute the income in a tax-effective way.
Additionally, you will enjoy a 50% CGT discount. You will also have greater asset protection because you won’t be the legal owner and creditors won’t have easy access to the assets.
In a trust, the trustee holds the business for the beneficiaries. A trustee can be an individual or a company and they will be responsible for everything that relates to the trust. That includes income and losses.
One of the downsides of using a trust for property investment is that tax losses will be trapped in the entity. That means the losses can only be used against future trust income. This type of personal financial structure is generally not optimal for a property investment strategy that is pivoted towards making use of the benefits of negative gearing.
Self-Managed Super Funds
Last but not least, we have Self-Managed Super Funds (SMSF). This option has become increasingly popular in recent years. It consists of pooling superannuation assets, which increases your borrowing capacity. The use of superannuation to invest in real estate may save you a cash deposit.
However, getting into real estate investment with an SMSF structure means your investments will be subject to strict government guidelines.
SMSF can be a good option for investors who want to save for retirement and don’t have the need to access their income right away. Additionally, it’s a good option for those who don’t intend to sell the properties they purchase.
Combining all this knowledge into Strategic Investors’ personal financing structure scorecard
With the correct strategy and the right team to support you, building a property investment portfolio can be fun!
Don’t make hope your property investment strategy! It’s not enough to want it, you have to work it!
At Strategic Investors, we have made it easy to formulate your own strategy, no matter what level of property investment experience you have.
Deciding on the right personal financing structure is essential for success. Your investment future will depend on this decision, so you need to inform yourself as much as possible. Seek trustworthy advice and be thorough, this will allow you maximise your successes as you begin to build your property investment portfolio.
Here are some ideas you can implement now to help you start your journey. We’ve tailored these ideas to suit any level of experience for all types of properties:
Something for all users:
Subscribe Now to be a member, and be sure not to miss out on our 6-part property investment series on the essentials of personal financing structures for successful real estate investing!
Something for beginners
Setting up the right structure can be a daunting experience, and deciding on the right financial structure for your own circumstances can be a maze.
Understanding your long-term wealth strategy is often not as straightforward as one may think.
It’s vital to structure yourself correctly from the start of your investing journey to avoid costly financial restructures at a later stage.
Something for experts:
For the more experienced property investors, property turnover may be part of your long-term strategy to ensure you are optimising your investment. There may be ramifications of whether you can enact a specific investment structure. Before enacting any actions, seek professional advice from at least 2 sources to ensure you make one of the most crucial personal property investment life decisions.
Even if you are not about to do anything with your property portfolio, it is worth doing a planning and review exercise on your property portfolio to ensure that you are not sacrificing and missing out or incurring additional costs for inaction or lack of awareness.