Selling investments to LTC

Question from Klaus updated on 24th August 2015:

What I'm looking for is a little advice on investment property and tax.

We own our house - CV $1m. I owe $100k.

I bought an investment property 3 years ago for $1m. I owe $1m to the bank, current market value $1.4m (with Auckland's rapid price increases).

Now I'm thinking, how about creating a LTC and sell the investment property I own to my new LTC, and borrowing the $1.4m to use it to pay back the $1m and $100k - i.e. be mortgage free and buy a beach bach for the $300k (if I'm lucky).

The investment property rent income is $60k p.a. and the $1.4m loan at 6%, the interest cost is $84k - i.e about $30k loss p.a. after tax, return $20k which is about as much as we pay for our $100k loan interest p.a.

Do you think it is a good idea? Would the IRD & bank be OK with this?

Later on, I could always sell the bach to the LTC as well.

Our expert Mark Withers responded:

I don't believe this will fly with IRD. While the IRD did issue a confirmation after the introduction of the LTC regime that a LTC could still be used to restructure someone's affairs when they were renting out a personal home and buying another, your proposal goes beyond this.

This is because the property is already owned and rented. Presumably the LTC would also be owned by the same people that own the property now. This means there is no effective change of ownership with the outcome being that you are simply gaining a tax advantage by converting personal debt to company debt. The test for tax avoidance is whether there is any commercial basis for the transaction. Where the transaction is purely designed to derive a tax advantage with there being no other commercial basis for the transfer the arrangement fails the test and would be voidable. I believe this to be the case with your proposal.

Be mindful also that you would be booking a gain of $400k on a property you have only owned for three years. Because of the short timeframe you open yourself up to the prospect that IRD argues you acquired it to sell, and attempts to tax the gain on sale to the company. This risk is avoided if no sale takes place.

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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