Welcome to the second article in our 6-week series about personal financial structures and property investing. This article will focus on property investors who invest as individuals.
Having covered the typical profile of a real estate investor who chooses to invest through an individual property investment structure in our first article, we now delve into the advantages and disadvantages of investing in property as an individual.
Before we move on to the main topic, here is a recap of which type of investors often invest as individuals. They are high-income earners and first-time investors who want to take advantage of negative gearing. The flexibility of individual property investing also makes this structure so attractive.
It is also worth noting that, when it comes to property investing, there are significant overlaps between investing as an individual and investing jointly with a partner or spouse.
Advantages of Capital Gains Tax on property is a major reason to invest as an individual
Property investing as an individual, or even jointly with a partner or spouse, is a very flexible way to invest in property. When one is of a younger demographic, mobility is especially important. One would also expect that there is a higher frequency (and higher chance) of career mobility. There is also room to move higher on the property ladder in terms of the size and/or value of a property investment. All this means that flexibility is generally very important to a first-time property investor.
The flexibility available to an individual (or joint) property investor is that buying, selling, and renting decisions are not dependent on anyone else. On a relative scale, this makes investing as an individual the most liquid form of property investment compared to other personal financing structures, all else being equal.
One of the most advantageous factors of investing in real estate as an individual is that investors who are Australian residents for tax purposes and who have owned a property for at least 12 months have the advantage of reducing the CGT on investment property by 50%. This is a major deciding factor for a first-time investor because it fits so well against the typical profile of a first-time investor.
Furthermore, the low compliance requirements and non-existent setup costs make the choice of investing as an individual so attractive for many first-time investors.
High-income earners have the benefit of negative gearing. Again, this is highly advantageous for first-time investors because a large loan is typical amongst most of these property investors.
Property investing as an individual does have its disadvantages
There are some disadvantages to real estate investment through an individual financial structure. The first is that income generated from your investment property will be taxed at marginal tax rates, which can be as high as 47%. Whilst this may not be a factor in the first few years of a first-time property investor, it will become an issue as the property portfolio investing journey matures. Coupled with the generally accepted norm that working professionals in Australia see exponential increases in their income over time, a 47% marginal tax rate for a savvy real estate investor is not unimaginable.
Secondly, you are your own legal entity when you invest as an individual. This means that you won’t have much asset protection against risks. As the investment property owner, you will be liable for the property. This risk applies to joint property owners when investing with a partner or spouse.
Thirdly, income generated from the property will be fixed on the owner. So efficient tax distribution is not an option under this personal financing structure.
With the right team of advisors, individual property investors have bonus advantages
Being supported by a team of experts is an integral part of a successful property investment strategy. A bonus factor to consider when investing as an individual (or jointly) is the additional benefits to CGT on property available to first-home buyers.
CGT is exempt from an individual’s primary residence. Furthermore, suppose an owner moves out of a primary residence and rents out this property without buying a new primary residence. In that case, the property remains a primary residence for six years before it loses its primary residence status. This means that a first-home buyer turned rentvesting individual can earn rental income for up to 6 years and still be exempt from CGT on property.
This concept is best described with an example:
- Consider Julia, a highly skilled marketing professional earning a good income and has saved up enough for a deposit for her first home early in her career.
- Julia bought her Australian two-bedroom apartment off the plan 11 years ago, taking advantage of first-home grants available on new builds and further grants to first-home buyers.
- Two years later, Julia moves into her newly built home.
- A further two years later, Julia took up a fabulous opportunity to work in New York.
- Julia becomes a rentvestor, renting out her home during her five years in New York.
- During Julia’s time rentvesting, she could have sold her home exempt from CGT if she wanted to.
- Nine years after buying her first home, Julia returns to Australia to get married. She decides to settle back into her first property with her husband.
- Two years later, Julia has the great news that her family will welcome a little one into the family. She now has options to:
- Sell her home without incurring CGT on property immediately.
- Moving to and renting a larger home while she becomes a rentvestor for a further six years before deciding to sell without incurring CGT on property.
- Buying a new property as a primary residence and “selling” the property into a separate legal entity as she levels up her property investment skills.
All this would not be possible if Julia did not educate herself by working with a property investment expert like Strategic Investors. She built herself a competent team of experts (like an accountant) to formulate a bullet-proof property portfolio investment strategy.
Weighing up the pros and cons of investing as an individual
We have created a Strategic Investors Personal Financing Structure scorecard that helps our clients implement a successful property investment portfolio strategy from day one of their property investment journeys.
We will weigh up the pros and cons of individual property investing using the seven criteria listed on our scorecard. Strategic Investor clients, members, and readers of our blog use these criteria as a standardised measure to compare the most common legal entities available to real estate investors to formulate the best possible strategy to build their investment property portfolio as quickly as possible to reach their financial freedom goals.
- Leverage: Individual property investing is the least leveraged of the personal financing structures available to Australian property investors. The deposit for a property and how much you can borrow are limited to your borrowing capacity as assessed by lenders. Our general advice score: 2/10 for Leverage.
- Compliance: This is a significant advantage to property investing as an individual compared to other types of personal financing structures. Our general advice score: 10/10 for Compliance.
- Setup Costs: Setup costs are highly correlated to the level of compliance imposed on various legal entities. As such, our general advice score: 10/10 for Setup Costs.
- Asset Protection: Investing as an individual offers the lowest level of asset protection. You are legally liable for the property. Furthermore, if you are sued, your property will not be protected from the plaintiff’s reach (person filing the suit against you). Our general advice score: 1/10 for Asset Protection.
- Property Taxes: With any legal entity, there are always advantages and disadvantages from a tax perspective. With the CGT on property advantages available to an individual property investor, our general advice score: 8/10 for Tax.
- Liquidity and Flexibility: From an outright ownership point of view i.e., being the sole property owner, the personal property investment structure would have a perfect score. However, in the coming weeks, we will share further ways where real estate investors can gain a foot onto the property ladder with even higher liquidity and flexibility. General advice score: 7/10 for Liquidity and Flexibility.
- Wealth Transfer: Much like the relationship between compliance and setup costs, wealth transferability is highly correlated with the advantages and disadvantages of taxes. Advantages in capital gains tax on investment property available to individual property investors are a plus. Still, for larger property investment portfolios, the attractiveness of investing as an individual quickly evaporates. Our general advice score is 6/10 for Wealth Transfer.
Our verdict on property investing as an individual
The circumstances of every single property investor are different to another. An individual’s property investment strategy is as unique as their own fingerprint. Always seek the advice of a professional when deciding on investment matters.
That said, our average general advice score for the individual property investment structure is 6/10. We have some closing remarks aimed at different levels of investment property experience, which are highly correlated with the number of years an investor has been investing in property.
Verdict for property investors who are beginners: Investing as an individual is one of the best ways to get your first step on the property ladder. With the flexibility and liquidity available to you as an individual, combined with the low levels of compliance, setup costs and the advantageous tax benefits such as negative gearing and CGT on property discounts, our general advice score for this group of investors gets a bump up to 8/10.
Verdict for property investors who are experts: As any property investment portfolio grows overtime, the need for asset protection increases exponentially. Australians work so hard to earn an income and create wealth, asset protection, wealth transfer, and tax advantages that benefit a positively geared property investment portfolio become increasingly important. Our general advice score for this group of investors for individual property investment structures is 4/10.