Investing in real estate

Registering a company offshore for the purpose of holding an investment in real estate is one of the most common uses of offshore companies.

When investing in real estate, the investor has the option of either buying the property in his personal capacity or registering a company to hold the investment. There may be valid reasons for holding property in a personal name, such as the existence of state restrictions which disallow corporate ownership of real estate or perhaps potential tax benefits for holding investment property personally.

At the same time, however, a number of disadvantages can result from holding investment property personally and not through a company. Firstly, there are the complications associated with the transfer of the property in the event of death. Granting of probate and administering a will can be a time consuming and costly exercise. Furthermore, if inheritance taxes apply, the cost of transferring the property to the new owners can be quite substantial. Both of these problems can be avoided by registering a company to hold the property, since in the event of death there will be no need to effect any transfer of the property. It will simply continue to be held by the company and all that will be needed will be a redistribution of the company’s shares. Through appropriate planning before the owner’s death, it is possible for the shares to be instantly redistributed in a way which will not result in any financial outlay.

There may also be significant tax benefits associated with registering a company to hold the property. Consider the example below.

The first step here is registering a company in a suitable offshore jurisdiction where no tax will apply, such as the British Virgin Islands. Let us assume that a suitable investment property has been identified, which can be purchased for $200,000. Depending on where the property is located, it may be possible for a local bank to provide mortgage finance to assist with the purchase. In London, for example, it is quite normal for investment properties to be bought through BVI companies borrowing up to 70% or more of the purchase price from local banks.

Once the company has secured a loan for 70% of the purchase price, the bank will lend $140,000 to buy the property, while the company’s shareholder will need to contribute the remaining $60,000 as a loan to the company. The company will then buy the property and rent it out to generate rental income. The rent received will be used to repay the bank loan.

In the first few years, the interest on the loan will be quite high in relation to the rental income. This means that the company’s profits will be low, even though the value of the property will typically be appreciating. If the company’s income is taxable in the jurisdiction where the property is located, which is usually the case, this means that the company will not be paying much tax. Note that in any event, no tax will be payable in the jurisdiction where the company is registered.

In later years, as the rental income increases and the interest on the loan is reduced, the company’s profits will rise. If the rental income is taxable, then the tax will also rise. The usual strategy at this point is to add a second property to the portfolio. The bank will now consider the combined value of both properties in calculating its 70% lending ratio, which means that the shareholder’s contribution for the second property will be substantially less than 30%.

To illustrate this, let’s assume that 4 years after the first property is purchased, it is worth $280,000 and that the balance of the loan has been reduced to $110,000. The purchase price of the second property is $300,000. The combined value of the properties is therefore $580,000. If the bank is prepared to lend 70% of this, the total lending will amount to $406,000. But as there is still a balance of $110,000 owing on the first loan, the amount of the additional loan will be $296,000. This means that the shareholder will only need to contribute $4,000 for the purchase of the second property.

The interest on the two loans will once again be quite high compared to the combined rental income, so the tax exposure is now back to low levels. This cycle can be repeated in the following years, acquiring more properties whenever the effective loan to value ratio of the portfolio drops too low. Many investors have successfully used this strategy to build up substantial property portfolios over the years.

In the illustration above, we have assumed that tax will apply on the rental income in the jurisdiction where the properties are located. Provided the rental income is taxed at a lower rate in that jurisdiction than in the shareholder’s country of residence, then registering a company to hold the properties will obviously lead to tax savings, as the rental income will not form part of the shareholder’s personal income and will therefore not be taxed at the higher rate.

The tax exposure can be further reduced by utilising a second offshore company, as follows:

In this case, we are registering a company to act as a financing vehicle. The shareholder will now own both companies but he will place his contribution in the finance company. This may be structured as a purchase of shares in the finance company, so that no interest is payable to the shareholder. The finance company will then lend the money to the property investment company on the basis of a commercial loan agreement, so that interest is payable on the loan.

The interest received by the finance company will not be subject to tax in the jurisdiction where the company is registered. However, the property investment company’s profits will now be reduced even further, as the company will be paying interest on the entire 100% of the purchase value of the property, as opposed to only the bank loan of 70%. As the profit is lower, the company’s tax will also be reduced and probably even completely eliminated.

This illustration demonstrates how registering a company offshore can be a very effective tax planning tool in the case of investing in real estate. Another common practice, where properties of a substantially high value are concerned, is registering a company to hold each individual property. This allows the possibility to sell the property in the future by transferring the company’s shares instead of the property itself. The stamp duty on property transfers is usually extremely high. By transferring the company’s shares instead of the property itself, the stamp duty is avoided.

While the examples above show how registering a company offshore can be a powerful tool for investing in real estate, professional advice should always be sought before taking significant financial decisions.

Registering a company through Offshore Company Solutions is very fast and efficient. Shelf companies are usually available for immediate use for the most popular jurisdictions. In order to proceed with registering a company, all you need to do is click on the Incorporate Now button below and you could have your company within a matter of hours.