Property Investment - START AT THE BEGINNING!

"The most important aspect of making money out of property is preserving and protecting both the property and the wealth that is created.

Far too many property investors rush into buying properties without first getting a suitable property investment structure in place. Without a suitable property investment structure you are exposed and vulnerable to creditors who can ruthlessly take away everything you have gained." - Jason Lee


The importance of choosing the correct business entity for the right type of investment (before making the investment) cannot be over-emphasised. This decision determines the protection, method of succession (passing the investment onto future generations at death), style of ownership (management / administration / flexibility) and tax treatment that the investor will enjoy or be obligated to by that investment.

You could probably buy property in your name if you only want to own one property. People are often advised to buy their primary residence in their name due to the capital gains exemption. But if you want to build a property portfolio (aka the best way to build wealth), you need to have a proper structure in place.

I will therefore only consider Companies and Trusts as viable options in this Blog Post.  

[Close Corporations are being phased out but since there are still a few floating about, my comments on Companies would apply in the same way to Close Corporations.]

I will discuss each entity by referring to each of the aspects that I have already mentioned.

  

TRUSTS

When you buy property in a Trust, it is possible to build a much bigger portfolio than you would be able to in your name. Trusts are mostly more suited for more passive/holding investments (e.g. holding a trading company’s shareholding). They are also more suited to Family investments with a common goal.

Protection

I kicked-off this post with a quote from well-known property investor and author, Jason Lee.  I share his sentiment that protecting your wealth is as important as creating it.  The proper use of Trusts can create investments that are 100% creditor proof. However, please note that such protection can only be achieved over a period of time and through effective management of your Trust. 

I favour a double Trust structure as the best defence against Creditors. There are a couple of people who claim credit for this structure but, in my opinion, it stems from a book by Peter Carruthers called CrashProof your Business and developed by Rob Velosa.  Irrespective of who developed it, this structure is recommended by a vast number of the Trust experts and gurus in South Africa.

Method of Succession

  • did you know that on your Death, your Estate may lose up to 55% in fees and taxes?
  • did you know that these are expenses that must be paid by your heirs?
  • did you know that on your Death, your assets will be frozen?

A great benefit of Trusts is that it does not form part of your estate if you are declared insolvent or pass away. There are no estate duties, capital gains tax or executor fees. No assets are frozen. You will not have this benefit if you use a company unless a trust owns your company’s shares.

Style of Ownership

Trusts are created by the Founder and managed by Trustees for the benefit of Beneficiaries.  The Founder can be both a Trustee and a Beneficiary.  There are several reasons why it is essential to have an Independent Trustee (follow the Link) and the owner cannot treat the Trust ownership of the Assets as an extension of his personal ownership.

Tax Treatment

The conduit principle that only applies to trusts is also a great mechanism to channel and split profits or capital gains to beneficiaries, which makes a trust even more tax efficient.

 

COMPANIES

Buying property in a Company makes sense if a trust owns the company, but this structure can be more expensive. Company structures are most suited where investment/business risks/liabilities are high.

Protection

Section 77 of the Companies Act prescribes certain statutory liabilities, which are placed on the directors of a company. A director of a company may be held liable for any loss, damages or costs sustained by the company as a consequence of any breach by the director of the duties contemplated.

A director of a company will, in addition, be held liable where that director:

  • purports to bind the company without the requisite authority;
  • acts in the name of the company in a way that is false or misleading; or
  • knowingly or recklessly signs or consents to the publication of a financial statement which is false or misleading.

The Act further provides for the liability of directors, where they trade recklessly or conduct the company’s business with the intention of defrauding a creditor.

Section 214 of the Act renders a director (or any person) guilty of a criminal offence if such director / person was knowingly a party to an act or omission by a company calculated to defraud a creditor or employee of the company, or a holder of the company’s securities or with another fraudulent purpose.

In terms of both the Income Tax Act and the VAT Act, all juristic persons are required to appoint a representative taxpayer who accepts responsibility for ensuring that the company meets its tax obligations. Even though the Acts afford certain protection to these representative taxpayers, this is paltry compared to the onerous provisions of section 48(9) of the VAT Act and section 16(2C) of the Fourth Schedule to the Income Tax Act.

However, as yet no court has had the opportunity to consider these provisions; leaving one with little certainty as to how these elements will be interpreted.

Method of Succession

A company has “perpetual succession” – it survives the death/incapacity/insolvency/exit of the directors and shareholders. ... Transferring ownership and management is easy – shareholders and directors change but the company lives on.

Style of Ownership

Companies are owned by the Shareholders and managed by Directors.  The Investor can be both a Shareholder and a Director.  The South African Trust Law is not nearly as developed as its Companies Act counterpart and therefore greater legal certainty exists regarding rights and obligations surrounding Companies.

In my experience, where there are groups of people investing together, a Company is the most nimble vehicle to accommodate the entry and exit of Investors (death, insolvency, sale of shares, etc.).  A Trust is extremely cumbersome when having to cater to shifting investor demands and expectations.

Tax Treatment

And although the tax rate is lower, the conduit principle does not apply, which makes it very inefficient to move funds out of the company and benefit from your portfolio.


WHY IS THIS THE BEGINNING?

Moving assets out of one legal entity (or from a Natural Person) into another can trigger donations taxes (at 20%), deemed interest charges (at 8%, Section 7C), capital gains tax (CGT) and transfer duties.

I prefer a combination of Trusts and Companies but each individual Investor is different and should seek their own advice.

Getting things right from the start will save a lot of time, money and aggravation down the line!


Visit www.elegantcorp.co.za for a 100% FREE consultation.


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Denny Crane

Denny Crane
It's not me ... yet. Denny Crane from the TV series Boston Legal. Click on picture if you're not sure who he is!