Investment in a commercial property is a big financial decision but one that in the right economic environment – and in the right location – can be lucrative.
Those who invest in commercial property pay tax on the rental income they earn from the asset, as well as any profit made when they eventually sell the property.
Tax is an important consideration when it comes to any investment and so it’s important to understand that the tax calculated on a commercial property investment depends on the type of business structure you use to purchase the asset.
We outline the tax implications for main business entities in this article, though if you have questions or concerns you should always consult experienced legal practitioners such as Big Law who can advise you on all matters related to purchasing commercial property.
Business entities and owning commercial property
Individual: Like being a sole trader, owning an investment property in your own name is a simpler, cheaper option when compared with doing so as a company. For an individual owner, rental income is incorporated as part of your assessable income and taxed at your marginal tax rate. This means negative gearing losses on the property may be offset against your income. If you later sell the property and make a capital gain, a 50% CGT discount is available so long as you’ve owned the asset for at least 12 months before it is sold.
Partnership: The law defines partnership as a contractual arrangement where at least two parties carry on a business in common with a view to profit. When partners own a commercial property together, the tax law regime considers them also a partnership for income tax purposes. The liability of each partner is jointly and severally held, meaning the personal assets of all the partners may be at risk to risk if one partner is sued for an act conducted in the name of the partnership.
Each partner claims a share of any net profit or loss incurred by the partnership. If the commercial property owned by the partnership is negatively geared, therefore, a partner may offset their share of the net loss against their own income. Similarly, if each partner is an individual or a trust, the 50% CGT discount will apply if the property is sold and a capital gain is made, provided that the property has been held for at least 12 months before its sale.
Company: Because a company is recognised as a separate legal entity at law, buying a commercial property under a company structure means the asset is potentially at risk should the company be sued or become insolvent.
On the positive side, tax paid on the property’s net rental income is calculated at the corporate tax rate of 30%, generally lower than a high-earning individual’s marginal tax rate (inclusive of the Medicare levy). Capital gains are also taxed at 30%, and the company, depending on its size, may be also be eligible for small business CGT concessions offered by the ATO. However, any negative gearing loss on the property will be absorbed by the company and cannot be used to offset another entity’s income. The loss, however, can be carried forward indefinitely or used to offset the company’s future income and capital gain if the property is sold.
Companies must also pay GST on one-eleventh of a commercial property’s sale price, but can claim GST credits on purchases that relate to selling the property.
Trust: There are different forms of this entity, including unit trusts, family discretionary trusts and hybrid trusts. The key advantage of a discretionary trust is that if a commercial property asset is held by the entity, the asset is protected in case of litigation against a beneficiary of the trust because that person is not entitled to income and/or capital of the trust. This is the case unless the trust elects to distribute income from the asset to beneficiaries.
Further protection is offered by the fact a corporate trustee that does not carry on any activity in its own right, can be used to purchase the commercial property. A discretionary also offers good asset protection from the tenant should they fall on difficult times.
The other main benefit of a trust is taxation. The trustee can distribute different amounts of annual net rental income to different beneficiaries based on their tax position each year, minimising the tax liability of each beneficiary. In addition, if the trust makes a capital gain after owning the property for at least 12 months before it is sold, the 50% CGT discount will be available if the capital gain is distributed to an individual or another trust.
A negative gearing loss on the property, however – as in a company structure – is absorbed within the trust unless it has other income, such as from another trust, to offset the loss. .The tax loss can be carried forward indefinitely and only recouped if certain trust loss recoupment tests are satisfied.
Self-managed super fund (SMSF): Using this entity for purchasing commercial property is considered lengthy and complicated but the lure is the substantial tax benefits to be gained in doing so.
That’s because rental income from the property flowing to the SMSF is taxed at 15% and drops to zero at the time the fund moves into its pension phase.
SMSFs can claim a capital gains tax discount of 33% while the fund is in the accumulation period, after the asset has been held by the fund for more than 12 months. The fund pays 15% tax on two-thirds of the capital gain, equal to 10% of the total capital gain, and is exempt from CGT during the fund’s pension phase. Negative gearing the property under the SMSF structure is not as effective as for an individual, because the losses are only offset against income taxed at 15% during the accumulating phase.
SMSF entities must be registered for GST if they own a commercial property and annual turnover exceeds $75,000. GST must be paid on one-eleventh of the sale price, but GST credits can be claimed on any purchases that relate to selling the property.
It should be noted that, generally speaking, there are tax deductions commercial property owners can claim under the business entities outlined above. These include on interest paid on the loan used to purchase the property, travel costs related to attending the property, repair, maintenance and property management expenses, and depreciation of the asset.
The benefits of legal expertise
It’s clear that the benefits, risks and tax implications of buying commercial property can vary considerably depending on the entity used to make the purchase.
For expert insight into the ideal structure for your situation, speaking with experienced legal practitioners is highly advised so that you are fully informed before making such an large and important investment decisions.
At Big Law we provide holistic legal solutions to legal matters.
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