Rental transfer to LC

Question from David updated on 18th May 2016:

I have seen the various answers with respect to transferring rentals to LTC, but I would like to ask it from a different approach.

My wife and I have a couple of rental properties acquired a number of years ago, and did not at the time set up a company for them. (This was about 20 years ago, and we were both overseas). Now we are back in the country and we are looking the possibility of moving the rental properties to a Limited Company (not a LTC).

The aim of this is to make tax reporting easier, to clarify the tax structure, and to provide a future platform for more investment purchases in the future. But would the IRD see this as tax avoidance, as we are not looking at the LTC setup to pass losses (if there are any) on to our own income?

We would be selling them to the company at the value that would cover the current mortgages on them and to cover the historical deprecation on those properties

Our expert Mark Withers responded:

I would be wary of this plan.

Firstly, any sale to a related party must be at market value. This is likely to trigger a full depreciation recovery with resulting tax payable.

Secondly, there may be a small tax saving in a company given it has a 28% rate. Whether this constitutes tax avoidance is probably determined primarily by whether the decision to restructure is tax motivated. Even then though, a distribution of a dividend by the company will be taxable to the shareholders and if their rate is 33% a top up tax payment is required of 5%.

Thirdly, there is a problem accessing capital gains in closed companies. If they are distributed as dividends these dividends are taxable. The solution is to liquidate the company prior to distribution. This is problematic though if properties remain in the company. Neither the LAQC nor its replacement the LTC suffer from this problem and was a big reason for their popularity over and above the flow through of losses.

Fourthly, the two year clock for the new bright line test will be reset for the company meaning that if the company sold within two years these gains would be taxable to it.

So, overall, I'm struggling to see much of an upside with this for you and can't imagine the goal of "making the reporting easier" is really achieved by this. There are, in fact, more onerous reporting requirements for companies.

Mark Withers and his team at Withers Tsang & Co specialise in advising on property related transactions, valuation and restructure services and tax planning.

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