Property investment company: reduce CGT by 28%! 

Typically, accountants tend to advise against using a private company structure to hold geared property investments. However, investors shouldn’t automatically dismiss this approach, as it can provide substantial capital gains tax (CGT) savings. 

Commonly cited disadvantages of a company ownership structure  

There are two main disadvantages of using a company structure for property investment: 

1. No immediate benefit from negative gearing: Companies cannot distribute losses directly to shareholders. Unless the company earns other income to offset rental losses, these losses remain trapped within the company, carrying forward to future years. This means investors may lose the immediate tax benefits associated with negative gearing. 

2. No access to the 50% CGT discount: The 50% CGT discount is only available to trusts and individuals who hold an asset for more than 12 months. For individuals at the highest marginal tax rate (47%), this discount effectively caps CGT at 23.5% of the net gain. Conversely, a company pays a flat tax rate of up to 30% on capital gains. This could result in paying at least 6.5% more in tax compared to individual or trust ownership. The tax disadvantage could worsen if profits are distributed fully as dividends in a single year, resulting in substantial additional personal tax liabilities. 

Although these disadvantages are valid, some investors may successfully manage or entirely mitigate them through strategic planning. 

Negative gearing: Structure for PAYG employees 

Negative gearing allows you to reduce tax by offsetting rental property losses against other income, such as salary or wages. This tax benefit makes property investing more affordable because it lowers your annual cash outlay. In simple terms, reducing your holding costs improves your overall investment returns. To maximise your investment returns (internal rate of return), you must aim to maximise the benefits from negative gearing. Typically, this means borrowing personally so that interest expenses can directly offset your salary or wage income. 

If you are a PAYG individual looking to hold property within a company but still maximise negative gearing, there’s an alternative approach. Instead of the company borrowing directly to buy property, you can personally borrow funds to purchase shares in your new company. 

PAYG: Here’s an example  

Here’s a simplified example for a PAYG employee: 

1. You establish a new company, which issues you 1 million shares at $1 each, totalling $1 million. 

2. You borrow $1 million from the bank personally to buy these shares. 

3. Your new company now holds $1 million cash raised from issuing shares and uses that money to purchase an investment property. 

4. Because you personally borrowed the money to buy the shares, you can claim the interest on that loan as a personal tax deduction, effectively achieving negative gearing in your name. 

These 4 steps could occur simultaneously, so that the bank could use the Company’s new property as security for the loan.  

The rental income earned by the company can either be distributed to shareholders as dividends or retained inside the company for reinvestment or debt reduction. 

PAYG: What happens when the company sells the property?  

When your company eventually sells the property, it pays tax on any capital gain at the flat corporate tax rate of up to 30%. Importantly, profits can remain within the company and be distributed gradually over time to minimise your personal tax liability – more on this below. 

The company can then return capital to the shareholder, so they are able to repay their loan. For example, the company can reduce the face value of each share from $1 down to $0.01 (or lower), effectively returning 99% of the initial capital to shareholders. Shareholders can then use this returned capital to repay their personal loans, typically without incurring any CGT liability.

  

PAYG: Other potential advantages and considerations  

A potential advantage of holding property in a company structure is flexibility regarding ownership. You can change the ownership of the property by transferring or selling shares in the company, typically without incurring stamp duty. However, it is important to note that a share transfer/sale will trigger CGT. 

Careful planning is required to avoid the “land rich” provisions, which generally apply if the company owns land valued above $1 million. If the company is deemed “land rich,” transferring shares will likely trigger stamp duty. 

If you have surplus cash savings or other income-generating assets, another option is to contribute these directly to your property investment company. The company could then use this income to offset rental losses internally. In this scenario, the borrowing could remain within the company rather than personally in your name.  

Negative gearing: Structure for self-employed taxpayers 

Borrowing to invest in property via a company structure can be simpler for self-employed investors, provided their business income arrangements are correctly structured. If so, you should be able to direct business profits into a dedicated property investment company to offset rental losses internally. In this scenario, the company itself borrows funds directly to acquire the investment property. 

Ideally, the shareholder of your property investment company should be a family trust. This provides maximum flexibility when distributing future income and capital gains and delivers asset protection benefits. 

However, the main drawback of this structure is that negative gearing benefits are restricted to the company’s own tax rate, either 25% or 30%, depending on your specific business income arrangements. This is significantly less attractive than negatively gearing at the highest individual marginal tax rate of 47%, thereby potentially reducing the overall tax savings available. 

Massive CGT saving: Spread the gain over 16+ years 

The key advantage of using a company for property investment is that shareholders receive a credit (franking credit) for any tax the company pays. So, even though the company initially pays tax at up to 30% on any capital gain, this tax is not lost, the shareholders claim it back when dividends are paid. 

Let’s use an example to illustrate this: Suppose a company makes a $1.5 million net capital gain from selling an investment property. Initially, the company pays tax of up to $450,000 (30%). However, rather than distributing this gain in one lump sum to shareholders, you could spread dividend payments over multiple years to manage individual tax rates effectively. 

For instance, assuming the company distributes grossed-up annual taxable dividends (i.e., dividend of $31,500 plus franking credit of $13,500) of $45,000 each to two spouse shareholders, effectively drip-feeding the capital gain to the individuals. Because shareholders receive franking credits equal to the 30% company tax already paid, and since their personal tax rate on income up to $45,000 per annum is only 18%, each shareholder would receive an annual tax refund of approximately $8,500. 

At this pace, the full $1.5 million capital gain can be fully distributed within roughly 16 years. Over this period, the total CGT paid after franking credit refunds is around $164,000. However, because tax was initially prepaid by the company, and shareholders receive refunds gradually, the present value of all tax paid is around $213,000. That equates to an effective tax rate of approximately 14% and a saving of approximately $82,000 amount 28%), compared to owning the property in personal names.  

In theory, you could further optimise this by spreading dividend payments over an even longer period, say, 37 years, to keep each shareholder’s annual taxable income below $20,000 (nil tax). At this level, the shareholders could reclaim all the company-paid tax through refunds. After accounting for the time value of money, this scenario would result in an effective tax rate of approximately 10%, which represents your best-case tax outcome – and is around half the rate of tax that you would pay in personal names.  

No land tax surcharge  

Unlike family trusts, private companies typically do not attract surcharge rates of land tax. This means a private company will usually pay land tax at the same rate as an individual owner. 

Victoria and NSW have “grouping provisions” that combine land holdings across related companies and tax them as one taxpayer. However, some states have more limited or no grouping rules, making it possible to reduce your land tax by holding properties in separate companies. But be cautious about structuring your investments solely to minimise one specific tax, as tax laws regularly change, and what’s advantageous today might become disadvantageous in the future. 

Downsides to a property investment company  

Every ownership structure has advantages and disadvantages. Some common drawbacks of owning property through a private company can include: 

• Initial and ongoing costs: It costs approximately $2,000 to set up a private company. Ongoing annual expenses include preparing financial statements, lodging company tax returns, and submitting annual statements to ASIC (which attracts an additional fee). In total, annual costs for a basic investment company typically range between $2,000 and $2,500 per year. 

• Borrowing limitations and complexity: If you borrow personally to purchase shares in the property investment company and need to use the company’s property as security for that loan, the company must provide a guarantee. Having a company involved in your loan structure reduces the number of lenders and loan products available. Typically, lenders will not allow offset accounts linked directly to these loans. Although the number of suitable lenders is smaller compared to standard residential loans, it’s unlikely you will need to pay higher interest rates or fees if you have a great mortgage broker.  

• Potentially more CGT: A major potential downside arises if you need to sell the property and want immediate access to the sale proceeds personally. In this case, the company must distribute the full capital gain to shareholders as a dividend in a single tax year (or create a Div. 7A loan). This could result in a tax liability of up to 47% on the capital gain if shareholders are on the highest marginal rate. Therefore, if your investment strategy includes selling a property to reduce debt, for example, a company may not be the optimal ownership structure.  

This is not an exhaustive list. Depending on your circumstances, there may be additional risks or complexities associated with owning property via a private company structure. 

It’s rarely all or nothing… 

Diversification is a valuable goal when structuring your wealth because every ownership structure has its own set of advantages and drawbacks. If you plan to own multiple investment properties, it’s worth considering holding at least one property within a company structure to take advantage of the advantages discussed in this blog.