Revoking LTC status
Question from Megan updated on 27th March 2019:
We have six rental properties which we have had in an LTC (originally LAQC) for over 10 years. The LTC is now making a profit and earning income each year.
But some banks have said they won't use income from an LTC for further lending applications. So we wondered if we should revoke the LTC status to an ordinary company status... But would this restart the clock for the properties and would we have to pay depreciation, clawback, etc?
We are also buying another investment property (a block of two units) and wondered if we should set up an ordinary company to buy these in rather than use the LTC as they will be positive income from day one.
Our expert Matthew Gilligan responded:
I think the first point here is confirming that any revocation of LTC status would get you the desired outcome with the bank. In my experience, the tax status of the company does not make any difference to the bank’s serviceability calculations and it would be surprising to me if it did in your circumstances.
Moving on though, a couple of points to note on revoking LTC status. As you seem to be aware, if you do so then you have a deemed sale of the properties owned by the LTC. This means if any of them were tainted or otherwise on revenue account you could end up with taxable gains.
Secondly, you can have depreciation recovery. Depreciation recovery arises where the sale price of the depreciable assets exceeds the depreciated book value. In this case, although there is no actual sale, there is a deemed sale which will be deemed to occur at market value. Thus if the market value of any depreciable assets exceeds book value, then you will have depreciation recovery to that extent, capped at the amount of the deprecation claimed.
You also raise a good question as to whether there is then a reset of the bright-line clock. Given that there is a deemed sale of the properties from the shareholders to the company as noted, there is an argument that there is a reset of the bright-line clock with the company then deemed to have acquired the properties at the point of revocation of the LTC status. This is not a position that is beyond doubt, as in my view the legislation is not clear, but at this stage I would err on the side of caution to suggest there is potentially a restart of the bright-line clock and proceed very carefully. Hopefully in due time the IRD will clarify their position as to how the legislation applies to this specific circumstance.
As to the new property, without knowing more of your circumstances I cannot comment as to whether you would be better off with an LTC or an ordinary company. There are some potential advantages of ordinary company status when a property is profitable from a tax perspective because you can take advantage of the company tax rate of 28%, although this generally produces a timing benefit only. On the other hand, capital gains cannot be released from non-LTC companies tax-free unless the company is wound up. You also need to think about the long-term picture and whilst you are saying that the property will be profitable from day one, you need to think about how it will perform in a higher interest rate environment or under differing scenarios such as periods of vacancy or high repairs and maintenance expenditure.
In closing, I would be cautious about revoking LTC status and question whether it is going to make any difference with the bank.Matthew heads GRA's specialist property and asset planning division. He helps clients create optimal tax structures and build wealth through property. He has an extensive buy-to-hold property portfolio, is currently involved in over a dozen developments, and is author of two books - Property 101 and Tax Structures 101.