There are two ways you can structure your property portfolio – in a Property Trust or a Company with the company’s shares held in a Holdings Trust. You might notice we didn’t mention having properties in your name, and here’s why. A trust protects your assets and makes estate planning a lot easier.
It is so important to have an entity own your properties and not own them in your personal capacity because: – You don’t want any assets in your name (for asset protection and estate planning) – You don’t want any large amounts of debts in your name (the more debt you have in your personal capacity, the more difficult it becomes to build your property portfolio further), and – The tax benefits are significantly better if you structure your properties correctly (the conduit principle in trusts or the lower income tax rates on companies).
But what do you do when you already own a property or multiple properties in your name? Should you restructure your property investment portfolio or not? The short answer is yes. While restructuring can become expensive, it is necessary because the longer you delay, the bigger your problem will become and the higher your costs.
There are THREE MAIN ADVANTAGES to restructuring your property portfolio. Firstly, you get the assets out of your name, which means better asset protection and estate planning. Secondly, you get the debt out of your name, which means a cleaner credit record and increased ability to build a bigger property portfolio. Lastly, you get to finance the properties at their new market values in the acquiring entity, making plenty of capital available through the restructuring.
A bonus is that you can use these funds as reserves or to expand your property portfolio further (of course, within the correct structure moving forward). Keep in mind that restructuring means you will need to incur transfer fees and new bond registration costs. However, these fees are reasonable for properties below R1 million and where there are not too much capital gains.
Unfortunately, transfer duties apply for properties valued at over R1 million, increasing the costs. Also, when there are significant capital gains, you’ll have to look at the capital gains implications of moving your properties over to the correct structure. Note: If you are selling your primary residence to your structure, the first R2 million capital gain is exempted.
To reduce your capital gains taxes, you can also utilise the R40,000 capital gains tax exemption per year per person. Consider the following example of how restructuring will look when selling a property to an investment structure.
Original Purchase Price = R900,000
Current Market Value = R1,000,000
Outstanding Bond = R700,000
Property Type: Investment Property
Ownership: Personal Name
Transfer Costs = ±R24,000
Transfer Duties = R0
Bond Registration Costs = ±R30,000
Bond Cancellation Costs = ±R4,000
Capital Gains Tax = ±R8,000*
*[R1,000,000 (Selling Price) – R900,000
(Purchase Price) – R40,000 (Annual Capital Gain Exemption)] x 40% (Inclusion Rate) x 35% (Tax Rate on Tax Bracket for this Example)]
Capital Made Available
(Before Restructuring Costs) = R300,000
The available R300,000 can be lent to the structure and parked in the access bond to avoid unnecessary interest on the higher bond. You can use these parked funds as reserves for emergencies, cover shortfalls, deposits, and transfer fees to acquire additional property. Take note, the loan from the individual to the structure incurs a deemed interest, which is a taxable income in your name.
However, exemptions on interest income and other exemptions could be applied to reduce these taxes (even to zero). We can see that the above approach will not make financial sense with a more expensive property with significant capital gains since the acquisition (transfer duties and capital gains tax become too much).
One could then look at transferring the property to your structure as an asset-for-share transaction (Section 42 of the Income Tax Act). An asset-for-share transaction makes it possible to transfer property from your name to a private company without paying income tax on capital gains or transfer duties by allowing a person to transfer properties to a new company in exchange for shares issued by the company.
This, however, is not a clean solution, albeit a much more affordable solution for expensive properties, as you would still need to hold shares of the company in your personal capacity. If you do end up implementing an asset-for-share transaction, it would be prudent to consider restructuring your estate to ultimately hold the shares through an inter vivos (a living trust) Holdings Trust. In the end, property investment can be lucrative and rewarding (and just plain fun) when your property investment portfolio is structured correctly!
SOURCES Prosperity Enterprises