Structure of Joint Commercial Property Investment Purchase

Posted On: Thursday, April 11, 2019

Two individual persons want to buy the commercial property together for investment. We would like to know the best business structure for this use regarding tax minimisation and asset protection.

Answer

Here are some variables (not exhaustive)

  • What is the gearing ratio, and will the property be negatively geared?
  • What is the investment horizon and how long do they intend to hold the property?
  • What is the commercial risk profile of the two individuals?
  • Are the two individuals at arm’s length? Meaning they are not family members.
  • What trading, and investment structures do the two individuals have?

The following comments are general in nature…

Given the purchase of a commercial property can involve a substantial investment by the respective parties, a partnership of two individuals is not advisable. This is because partners can be jointly and severally liable for assets they hold together.

In the event one partner gets into financially difficulties, the investment in the commercial properly by the other partner could be at risk. A partnership of two discretionary trusts with a clear understanding that the respective trusts only function is to invest in the commercial property, could be a better option.

If there are substantial negative geared losses a hybrid trust could be considered.

A hybrid unit trust is a mix between a discretionary trust and a unit trust. This means, the beneficiaries of a “hybrid unit trust” have some entitlements to benefit (generally as to income) that are fixed in their favour by the terms of the trust deed while other benefits (generally as to capital) will only come their way if the trustee of the trust exercises a discretion in their favour.

The trustee has the discretion to distribute income to the discretionary beneficiaries, and the unit holders then have a right to receive income and capital that has not been distributed to a discretionary beneficiary. Alternatively, the unit holders may be entitled to all the income of the trust but may have a right to redeem their units for face value, at which point the trustee will have complete discretion when distributing income or capital.

Essentially an individual borrows money and buys units in the trust personally, the trust buys an investment property, the individual claims a tax deduction and when the property is sold any capital gain goes to discretionary beneficiaries.

However, the Australian Taxation Office (ATO) has expressed a concern with hybrid unit trusts. One of their concerns is where units are redeemed for their face value as the property becomes positively geared. However, their main concern is the possibility of tax avoidance. According to them the un-commercial use of certain Trusts will provide a scenario in which the distribution of possible income/capital gains to beneficiaries of the trust who may have a lower tax rate in relation to the expenditure those lower tax payers laid out when purchasing those units. A loss or outgoing is not deductible where it is incurred to gain or produce benefits for other persons.

A hybrid unit trust is set up to combine the best elements of a unit trust with the best elements of a discretionary trust in the one entity and has both unit holders and discretionary beneficiaries. TD2009/17 confirms the ATO’s view that an apportionment is required between interest paid for income producing purpose (deductible) and interest paid for other purposes (non-deductible).

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