Building Duplex, Company or Personal ownership?

Hi all,
I am very new to this so please forgive me if this question is ridiculous. Also I am in the first stages of doing feasibility assessments on my options.

I am looking at buying and developing some land south of Sydney. At the moment there are 3 options, a) buy a parcel of land and build a duplex, b) buy a parcel of land, subdivide and build 2 homes, c) buy a parcel of land with an existing dwelling for renovation then build another home on the remaining land (may or may not be subdivided). All options are STCA.

My question is, what would be a better tax decision when it comes to how I buy, develop and then sell the land and homes. Should I do it as an individual/group of individuals, or should we set up a company and run it through the company? I currently do not own a primary residence but the other parties do. Borrowing from a bank can be kept to minimum, if that makes financial sense.
All advice is welcome.

 

You haven’t provided much info regarding your plans and personal position tax / earnings wise, but generally I would say individual. Company won’t receive the capital gains tax discount when you sell them. Even at the highest individual tax rate with a 50% discount you will be ahead compared to the corporate tax rate.

 

Thankyou for your response

 

That response by @Big A has a major flaw. A contruction and sale of new residential premises will not be a CGT asset so there cannot be a CGT event. It will be ordinary income. Same tax law whichg existed for decades before CGT started in 1985. After GST is considered. The company tax rate may be 25%...However that is not the final tax rate in most cases. A unit trust may also be a option in many cases as it can alter how each parties contributions are measured and give them a fixed entitlement to their "share" and more.

It needs some advice concerning the parties involved and how it will be financed and what is proposed with the profit, if any, that is produced. And which state too as land tax is a consideration. There are MANY more choices than A or B.

 

I'd suggest sit down with your accountant (or someone like @Paul@PAS who specialises in these scenarios) to work through this in detail. There are so many variables and pro/cons for each option so you really need to work through this in detail specific to your situation and future objectives.

For us, company structures have worked in the past.

 

Companies tend to favour those who repeat. This means the porfit is taxed at a low rate and can be reinvested into the next. The strategy can have risks and limits if projects seem to overlap but this too can be addressed. You never want two underway at any time. Then for unit trusts you NEVER want two properties in one trust ever without knowing the problems it can create. For those that want to rip the profit out on completion a company may cost far more in tax than the top marginal personal tax rate.

In many cases the arrangement when there are multiple parties can also complicate things. Then finance. You dont necessarily want two parties each jointly and severally liable. Legal advice is essential to such ideas. I have also found sometimes a group of people seem intended to be involved but a bank may have its own requirements for each borrower. One last year was all setup and ready and then the lender disliked one party and insisted they exit of there was no loan. The unit trust had to be reconstructed and resolved and then it progressed. Luckily it was early in process so no land rich duty issues came up.

 

Well there you go. The no capital gain for a new build resi doesn’t sound right to me, but what would I know. Why you should always get professional advice I guess. Definitely has me intrigued though, so I reached out to my professional for some advice on that just now. Will await their advice and share.

 

There is more to ownership structuring than tax.

If you make a loss personal name would be better, if you make a large profit a company could be better as it can stream income out in different financial years, it could retain profits too and pay 25% tax and use them for the next project etc.

If using a company next would be working out the structure of the company and you need to consider lots here, especially funding ability and taxation.

 

You may be horrified that many young tax students think this way. Unfortunately they are often taiught that CGT is a fundamnetal of tax. But it is never the first step in the solution.
A older and moe property focussed adviser will know that CGT and income tax can ovelap. There is a specific law that says if they do then IGNORE the CGT issue and the tax basuis prevails. In addition common law has been the relevant basis for determining if a property sale producces "ordinary income". This predates even the 1936 tax act. Thats 49 years before CGT was introduced.

Many also mistakenly think that for the income tax basis to apply there must be repetition. Wrong again. A isolated profit making intention is also caught and has been by these very same old tax law issues

There are basically Five taxing basis to property sales
1. Pre-CGT sales without a profit making intentions. (rare these days)
2. Pre-CGT sales where a profit making intention also occurs. (quite rare but not to be overlooked eg land banking by grandpa in 1978. Hard to argue he sought to produce income from vacant land other than to redevelop)
3. Revenue basis - Isolated profit making
4. Revenue basis - Business
5. CGT mere realisation. Without elemnet of profit making / enterprise evident
AND these issues can also occur with a main reidence or former land of a main residence or investment use land.

A tax ruling that demonstrates the ordinary income v CGT issues is TD 92/135 TD 92/135 | Legal database
Its a very simple ruling in reading it. But it imprtantly demonstrates the problem. And dont read too much into the example of "a builder"... A land owner can be in the same position where profit making is intended without construction (although exemption cant apply to vacant land) or with someone else constructing as part of the enterprise.

Many tax advisers do property related issues rarely and can be a poor source of advice and support. And make mistakes the taxpayer remains liable for. With penalties.

 

Tax aside - you should double check the borrowing capacity implications of borrowing under a company versus under a personal name. There are pros and cons associated with each structure.

 

Still awaiting the professional advice but decided to do some reading myself. Looked at TD 92/124. I’m no expert but geez is this a very grey area. What I understood is Whether it’s treated as income or capital gain has a lot to do with one’s intentions and execution of the said development. I guess some consideration needs to be given with regard’s to what you intend to do with the property and how you execute that.
So basically good professional advice is needed to ensure you get a desirable outcome.

 

Shahin, can you clarify the pros and cons of borrowing as a company vs personal names ?

 

Unlike a trust a company is a separate legal entity so its debts are not debts of the individual. A personal guarantee will be needed though and things are easily structured so the serviceability can be changed over time without triggering cgt or stamp duty

 

Personal entity will result in a higher borrowing capacity than a company entity for that specific application. This is because we can use negative gearing which would increase the borrowing capacity.

Company entities if structured correctly can stretch your borrowing capacity for future borrowings. For example, let's say your borrowing capacity is $500,000 and you purchase a property under ABC Pty Ltd and this loan is with say CBA. You can then set up a new company called "XYZ Pty Ltd" and purchase a new property - when you go to some lenders such as say ANZ then they will not consider the debt you have with CBA for ABC Pty Ltd (assuming its able to meet its own commitments). Therefore this gives you an additional $500,000 in borrowing capacity.

This is a very simple scenario and obviously the devil will be in the detail but something worth discussing with your broker or banker.

 

Loan Tip: The so-called ‘Unlimited Borrowing Capacity’ Strategy Loan Tip: The so-called ‘Unlimited Borrowing Capacity’ Strategy

 

If one has hit their borrowing limit personally can they just use a company to increase their serviceability ? So is the borrowing capacity of a company determined by the directors' income or is based on the deposit that the directors can provide ?

 

Most likely not - as the company application would still require servicing and the servicing is based on the income and liability position of the directors.

 

no because the lender is relying on your personal guarantee and personal borrowing capacity

but yes if you can bring in another director potentially.

Deposit doesn’t necessarily affect anything

 

If you bring along another director to Improve borrowing capacity, would this negatively impact each director’s personal borrowing capacities ? i.e. when assessing personal lending, do they look at your debt that is in the company or does the debt belong to the company ?

 

It will depend on a lot. Possibly not because the individual is not liable for the company debt unless the company defaults.

have a read of the other thread