Why I Don't Like Standard Companies
WHY I DON'T LIKE STANDARD COMPANIES.
When trying to set up the right structure, there are a few things that are looked at:
- Asset protection and your level of risk
- Flexibility - what is going to change over time
- Tax minimisation - how do we save you the maximum amount of tax
- Long term goals and strategy
- MOST IMPORTANT - Can we keep it simple?
Unfortunately, a lot of advisors miss another key component: What happens if you need or want to sell?
Issues with Standard Companies - Example
Tom and Jane have a personal house worth $1 million and debt of $500k.
They have a standard company that has:
- Block of flats worth $1.5 million and debt of $1 million (purchase price $1 million)
- New townhouse worth $550k and debt $450k
- New 4 bedroom house worth $750k and debt $650k (recently purchased 2016 for $650k)
- Tom and Jane have $50k shareholders current account.
Tom and Jane decide to sell the block of flats, and net of cost receive the $1.5 million. They pay off the $1 million debt and are left with $500,000 cash!
So what should Tom and Jane do?
They want to pay off their personal house and have it debt free. This would be pretty normal and normally a good financial move. So, without talking to their advisor, Tom and Jane take the money out of the company and pay off their personal house.
One year later they are getting their Financial Statements done: Do you think there will be an issue?
Yes - there is a MAJOR issue.
Tom and Jane have taken $500,000 that they are not entitled to. An easy argument is that $50,000 is repayment of the shareholders current account (would have been nice to have a Minute), so this leaves Tom and Jane with a $450,000 overdrawn current account.
The company has to charge interest on the overdrawn shareholders current account, say six months at 5.77% (presribed by IRD) being $13,000 approximately. The company would then have to return this $13,000 as additional income in the year and pay $3,640 in additional tax at 28%.
Some people will be thinking that's easy, there is a $500k capital gain on the sale of the block of flats. While the capital gain is correct, a standard company has no easy way to distribute these gains to the shareholders. It can distribute capital gains tax free upon liquidation, but that would mean having to liquidate the company. Liquidation would be expensive and messy as the other rentals would have to be sold, which would then mean the new 4 bedroom house would be caught by the 2 year Bright-line, and there would possibly be depreciation recovery or other costs.
There are ways to fix this issue in some circumstances, but that will incur additional costs to obtain expert advice and to make the changes. Also, some of the fixes take time, and Tom and Jane could easily pay $30,000 or more in unnecessary tax!
I hope you have found this informative. If you do have a standard company (not an LTC or QC) that owns rental properties, it would be worth having a free 5-10 minute chat with me, followed most likely by a one hour initial meeting to sort out your issue and give you the best advice going forward.
Kind regards
Ross Barnett
Disclaimer: This article has been prepared for the purpose of providing general information, without taking into consideration any particular person's objectives, financial situation or needs. Any opinions contained in it are held by the author as at the report date and are subject to change without notice.
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