At Paris Financial, the Tax Champions, we have a massive amount of clients who are trying to grow their passive wealth through property investment. Some do property development as well.
It’s a big thing in Australia, especially with the growth of the property market. I even do it myself.
If you are in a growing small business, however, you need to take a different approach to property investment.
Let’s imagine someone working in a big building in the city. If they are on a salary of over 100k per annum and are the main bread winner in their family, they will often develop their property investments with negative gearing.
Negative gearing
Negative gearing is when an investor borrows money to acquire an income-producing investment, and the gross income generated by the investment (at least in the short term) is less than the cost of owning and managing the investment, including depreciation and interest charged on the loan.
Here’s a classic example of negative gearing.
| Rent | $10,000 |
| Interest | $11,000 |
| Expenses | $4,000 |
| Loss | $5,000 |
| $5,000 x 0.3 | $1,500 |
The interest and the expenses are more than the rent, taking the sum into the negative. That gives you a $5,000 loss. You put this off against your tax, and the ATO gives you back $1,500.
An investment trust is important
In small business, a key asset protection strategy is to set up an investment trust outside of your main trading trust.
This investment trust is what buys your investment property.
You need to do this because you cannot have it in your name as the director of the company who is running the business. This is far too risky in a litigious society. You can’t have it in the non-working partner’s name because you will start to get hit with capital gains tax as well as paying too much income tax.
So, set up the investment trust. It will have the rent from that investment property, the interest, the expenses, and, therefore, you’ll end up with a loss. Still following along with my previous example, the investment trust will have the loss of $5,000 in it. The profitable trading trust then distributes to the investment trust and the $5000 is offset saving the $1500 in tax.
Trusts cannot claim losses. They need to be carried forward, UNLESS your profitable business distributes to it as above.
Hence, the key strategy for small business is to direct some of the profit from your trading trust or successful business, and offset the negative gearing in the investment trust.
