Tax implications of living in a rental property owned by your LTC
It is quite common for someone to buy or transfer what was once their own home, to a look-through company (LTC) or perhaps a trust or
partnership. Using an LTC etc. for residential rental investment can be a perfectly valid structure. However, the IRD consider some LTC
arrangements are made to avoid tax. Problems arise when an LTC buys an LTC shareholder's family home, and shareholders continue to live in
the home and claim deductions (for example, interest, insurance, rates, and maintenance) for the property. In most instances this is
considered tax avoidance. Expenses in relation to your private residence, whether owned by you, a company in which you're a shareholder, a
trust in which you're a beneficiary or a partnership you're a partner in, are not deductible. You may think that if you continue to pay
market rent to the company you can continue to claim these LTC expenses against your income. However, the IRD may still consider the
arrangement to be tax avoidance.
Tax avoidance carries penalties of up to 100% of the tax shortfall, and in some cases, such as deliberately misleading Inland Revenue about how the arrangement is set up, there is a shortfall penalty of 150% for tax evasion.
The new residential property deduction rules apply whether you hold the property yourself, or in a partnership, look-through company, or close company. The rules also apply to trustees of a trust who earn taxable income from a residential rental property. Now, you can generally only deduct expenses for residential property up to the amount of income you earn from the property for the year. Any deductions over your income from the property are called excess deductions, must be carried forward to the next income year you earn income from the property (or other residential property). This means that rental property losses cannot be used to reduce your tax liability for other income, such as salary and wages or business income.
Living temporarily in a property owned by your LTC
From time to time a shareholder will move into a home owned by their LTC which they previously rented to tenants. There may be good reasons why they do this. For example:
- inability to find tenants
- relationship breakdown
- relationships formed with tenants
- renovating or building your own home
But, if you live in the property and you are a shareholder, you generally cannot continue to claim what would otherwise be private expenses.
Whether or not this structuring and claiming of resulting losses is considered tax avoidance depends on several factors. For example,
whether the arrangement is permanent or temporary, and whether there are commercial factors driving the decision to live in the property.
Living with your tenants in a property owned by your LTC
The situation around tax avoidance is less clear when both a shareholder/owner and other tenants live in an LTC-owned home. The shareholder/owner's proportion of the expenses is generally not considered deductible. The IRD look at these arrangements on a case-by-case basis.
Some people claim the main reason for holding their personal residence in a limited liability company is for asset protection rather than to minimise tax. These structures provide little or no asset protection. For shareholders to make use of LTC losses, they must hold the shares in their own name. The market value of the shares of an LTC company that owns residential investment property is equal to the market value of the property and represents an asset to the shareholder, less the mortgage. A creditor claim equal to the current value of the property is possible. The IRD look closely at the reasons for such arrangements, but usually disregard the asset protection argument when considering if an LTC arrangement is tax avoidance.
If you are considering setting up an LTC to own your family/private home for tax loss claim purposes, be aware that IRD consider these types of arrangements to be tax avoidance.
If you are moving into your LTC-owned property over the long-term, consider taking the home out of your LTC. If you are moving into an LTC-owned property on a temporary basis, be careful not to claim a deduction for private expenses for the period you are in the home.
If you're considering any of the above arrangements then we strongly recommend you talk with our tax expert, Jono. 03 951 3162