In the current property markets where capital growth will be subdued for some time, more sophisticated investors are considering getting involved in property development to enable them to “manufacture” capital growth.
However, embarking on property development isn’t as simple as it might seem and unfortunately, too many investors begin their property development journey on the wrong foot.
By that I mean they start off without deciding the best business ownership structure and end up owning their entire portfolio in the wrong entity – often in their own name.
Rather than owning properties in your own name, there are several business structures that can be used for property development that might be better placed to help you achieve success, achieve financial independence and even get a tax benefit at the same time.
Here is a rundown of 6 business structures for property developments, with things you need to know about their key characteristics, governing documents and tax rates.
1. Company
A company structure is a separate legal entity run by appointed directors on behalf of the company shareholders (owners).
This is a popular business structure for property developers because the company sits as a separate legal entity that offers limited liability protection to its shareholders.
This means that the personal assets of shareholders are generally protected from business debts and legal disputes, which can be particularly important in the property development industry where the potential for large financial losses is high.
Note: Tax rate of a company - A significant benefit of using a company property development structure is that the income generated by that company is subject to a ‘company’ tax rate which is lower than the highest marginal tax rate for an individual.
For the 2021-22 financial year, companies in Australia with a turnover under $50 million are taxed at 25%, and 30% for companies with a turnover exceeding the $50 million base rate.
Of course, this is relevant if you’re considering undertaking property development to trade properties, but a company structure may not be the most appropriate ownership structure if you're planning to hold onto your development as a long-term investment.
The company tax rate for developments to trade is different to that if you will hold the development for rent.
Of course, this is only general advice and you really need to seek specific professional advice for your personal situation.
2. Unit Trust
Another business structure that can be used to undertake a small property development project in is a unit trust.
A unit trust is a type of trust where the beneficial interest in the trust is divided into units, which can be bought and sold by investors.
The trustee of the trust holds legal title to the trust property and manages the trust's affairs on behalf of the unit holders.
One advantage of using a unit trust structure for property development is that it can offer flexible ownership structures and allow multiple investors to pool their resources.
This can make it easier to raise capital for the project, as investors can buy units in the trust and receive a share of the trust's income and capital gains.
Additionally, the unit trust structure offers limited liability protection to its unit holders, similar to a company structure.
The unit trust will have trust deeds that set out the rights and obligations of the trustee, the unit holders of the trust and the rules for distributing income from the unit trust.
Note: Tax rate of a unit trust - In a unit trust, the net income and capital gains are distributed to the unit holders pre-tax.
In other words, the unit trust doesn’t pay taxes.
Instead, the unit holders are taxed on their share of the income at their own personal income tax rate.
3. Discretionary or Family Trust
A discretionary trust, also known as a family trust, is another option for undertaking a property development project.
A discretionary trust is a type of trust where the trustee has discretion over how to distribute the trust's income and capital to its beneficiaries.
A family trust is a type of discretionary trust that is set up for the benefit of family members.
One advantage of using a discretionary or family trust structure for property development is its flexibility and the fact that it may offer significant tax benefits to the beneficiaries.
The trust's income is taxed at the beneficiary's marginal tax rate, which can be lower than the trustee's marginal tax rate.
Additionally, the trust can distribute its income in a tax-effective way by distributing the income to beneficiaries who have lower marginal tax rates.
This can result in significant tax savings for the beneficiaries, but of course, you should seek professional advice on this so as not to fall foul of the tax legislation.
Another advantage of using a discretionary or family trust structure is that it can offer asset protection to the beneficiaries.
Since the trust holds legal title to the property, the personal assets of the beneficiaries are generally protected from business debts and legal disputes.
Like a unit trust, a discretionary or family trust will have a trust deed that sets out the rights and obligations of the trustee, the unit holders of the trust and the rules for distributing income from the unit trust.
Note: Tax rate of a discretionary or family trust - A family trust typically doesn’t pay any income tax from within the trust.
Instead, the income and capital gains are distributed to the beneficiaries, who are taxed at their own personal income tax rate.
Given discretionary or family trusts tend to be taxed on the net income of a trust, based on their share of the trust’s income it means that they are generally established for asset protection, estate planning or tax purposes.
4. Partnership
Using a partnership structure is another, but less commonly used, option for undertaking a property development project.
A partnership is a business structure where two or more individuals or entities join together to carry on a business together with a view to making a profit.
In the context of property development, a partnership could involve two or more friends or family members joining together to undertake a development project.
One advantage of using a partnership structure for property development is that it allows for the pooling of resources, skills, and expertise.
Partners can contribute different types of resources, such as capital, land, or labour, to the project.
This can help to spread the risk associated with property development across multiple partners, making it easier to access funding and manage cash flow.
Additionally, partnerships can be flexible in terms of decision-making and management, as partners can share responsibilities and decision-making power.
Partners can share ownership and decision-making responsibilities, which can be particularly useful if each partner brings different skills and expertise to the project.
Additionally, partnerships are relatively easy to set up and maintain, and there are fewer compliance requirements compared to other business structures such as companies or trusts.
However, each state and territory has its own legislation and governing rules when it comes to partnership business structures.
Another advantage of using a partnership structure is that the partnership's income is not taxed at the partnership level, but rather at the individual partner level.
This means that partners can offset any losses from the partnership against their other income, potentially resulting in tax savings for the partners.
However, there are also some potential drawbacks to using a partnership structure for small property development projects.
One is the potential for disputes between partners, particularly if there are disagreements about how the project should be managed or if there are disputes over the distribution of profits.
Another disadvantage is that it does not allow for individual ownership and if that is important when developing multiple sites then a co-development agreement is required.
Additionally, each partner is personally liable for the debts and obligations of the partnership, which means that their personal assets could be at risk if the project incurs significant financial losses.
A partnership also creates liability for both partners even if only one partner is being sued.
Although it's not essential, I would strongly recommend a partnership agreement be drawn up to govern the partnership.
Note: Tax rate of a partnership - One advantage of using a partnership structure is that the partnership's income is not taxed at the partnership level, but rather at the individual partner level.
This means that partners can offset any losses from the partnership against their other income, potentially resulting in tax savings for the partners.
5. Joint Ventures
A joint venture (JV) property development structure is another option.
A joint venture is a business arrangement where two or more parties come together to undertake a specific project or business activity, sharing in the costs, risks, and profits of the venture.
Each party can contribute different types of resources, such as capital, land, or expertise, to the project.
This can help to spread the risk associated with property development across multiple parties, making it easier to access funding and manage cash flow.
Additionally, JVs can be flexible in terms of decision-making and management, as the parties can share responsibilities and decision-making power.
The joint venture would be governed by a joint venture agreement, much like a partnership agreement.
Note: Tax rate of a joint venture - Similar to partnerships, joint ventures are generally not taxed at the joint venture level, but rather the income and losses are passed through to the individual parties.
This means that the parties can offset any losses from the joint venture against their other income, potentially resulting in tax savings for the parties.
Joint ventures can also allow for more flexible tax planning, as the parties can choose how to allocate income and losses among themselves to minimize their overall tax liability.
If undertaking development with multiple sites and each party wants individual ownership of a site then a co-development agreement would be required as well.
Splitting titles on completion of development triggers tax, GST and stamp duty which can in most cases be avoided with a co-development agreement.
6. Self-Managed Super Funds (SMSFs)
Please note that the following information is factual only and you should not enter into any superannuation transaction or strategy without seeking professional advice from a licenced financial planner that will take into account your specific circumstances.
Limited Recourse Borrowing Arrangements (LRBAs) mean that investors can now borrow funds to purchase residential property in their Self Managed Superannuation Fund (SMSF.)
While you can improve or renovate a property in your SMSF, property development in this structure is much more complicated and requires specific professional advice and a different structure.
The ATO, as the regulator of SMSFs, has released an information bulletin setting out the potential risks of property development activity through an SMSF and highlighting areas that can create compliance concerns.
There are specific areas of both the superannuation and tax laws that SMSF trustees need to be familiar with before entering into any form of property development, meaning SMSF trustees contemplating development activity involving their SMSF would need to work through the relevant rules and requirements.
Note: Tax rate of an SMSF - Rental income is taxed at 15% and capital gains at 10% during the accumulation phase.
When the SMSF moves to the pension phase the tax is zero within the SMSF and zero when paid to the pension member.
Tips: No matter which of the 6 property development business structures you decide to embark on, the characteristics, benefits and legal obligations can be technical and tricky to understand.
As such, you always have to ensure you seek out the services of professionals who understand the rules and legislation in your area because penalties for contravention can be significant.
To summarise, company or trust business structures (both unit trusts and discretionary or family trusts) are the most common option, while many also decide to go down the route of partnerships, joint ventures and even property investment through their SMSF.
It is also critical to consider finance and land tax when looking at the various structures as the outcome to these two questions can vary depending on the structure.
However, it's vital that you access professional advice before considering which property development business structure will benefit your long-term wealth creation and protection goals.
It is too late or costly to change structure after you have signed a contract of sale so get your advice early.
Our team at Metropole Wealth Advisory provide tailored strategic wealth advice for high-net-worth individuals and their families, professionals and business owners.
And we specialise in helping property developers set up the most appropriate entities for their needs.
Click here now to have a chat so you can learn about how we could formulate a Strategic Wealth Plan for you, your family, your business and your property development ventures.
