Want to guarantee that your home will be safe from any business adversity?

By Pete Carruthers

After I closed my business – Link Technologies – in 1992, I lost my home. That happened because I followed some really bad advice from an attorney. In talking with more than 20,000 SA business owners since then, it seems that such poor advice is pretty common. Most of the advice ‘professional’ advice we get is based on a shortsighted tax outlook – without even remotely considering the huge risks we smaller entrepreneurs run every day.

In my case I was advised to register my home in both my own and my wife’s name. The result of this advice was that we were both targets when the house went (along with everything else we owned) after the sureties attacked me. Yet, even now, I see this same advice often given.

As business owners there are a few core thoughts we need to consider when purchasing and holding property.

The first, and by far the most important, is risk. If you have ever signed any sureties in favour of your business – whether for an overdraft, asset finance, credit cards, office lease, fax machine, switchboard, photocopier, or anything else at all – then you must not register your home in your own name. One day one of those sureties will bite you – and the moment that happens, your home becomes a juicy target for the person chasing you.

If you are trading as a sole trader (sole proprietor) or in a partnership, then you must not register your home in your own name either. This is because the law regards you personally responsible for all the debts the business runs up – even those that you did not plan. Like the pizza parlour that burnt down and the insurers refused to pay because they found some minute technicality. Or the aggressive attacks by SARS when they merely think you owe them money. Or the lawsuit from a dissatisfied client who trips on your office stairs. The risks to a small business owner are infinitely varied and exciting!

If you are married in community of property and you (or your spouse) own a business of any nature, then you must not register your home in your own name either. This is because the law regards both of you as a single entity – and you are both fully responsible for any business, sole trading, or partnership debts!

In fact, the worst asset you can possibly have when you are attacked is a home that you personally own! Not only is it very, very attractive to potential attackers, but the fear of losing your home is emotionally crippling. I have consulted with hundreds of business owners under attack – and whenever a home was under threat I found the owner almost paralyzed with fear – and absolutely unable to negotiate meaningfully – terrified of making a mistake and losing the family castle.

Worldwide research shows that about 96 out of every 100 startups will fail in the first 10 years. That’s a huge amount of risk in anyone’s book.

The answer is so simple that it is laughable. Yet almost every financial advisor will quibble about it.Don’t register your home in your own name! And that’s where the complexity seems to creep in.

You see, I see our financial lives as a bit like a submarine. Every submarine is made of small watertight compartments, each connected to the surrounding compartments by watertight doors. If disaster strikes any one compartment, the captain simply seals the doors and compartmentalizes the damage into that one area. Of course it hurts! But it isn’t a catastrophe. Which it would be if that minor challenge in caused the entire ship to sink.

As a business owner the wisest course of action you will ever follow is to compartmentalize your life into watertight compartments so that challenges in any one aspect do not sink your entire ship!

If you aren’t going to register your home in your own name, then how should you do it? I am glad you asked. There are a few options that I will look at. But understand that I am way more interested in you still having this home in 20 years time, than I am in saving a few pennies now and losing the home to creditors in the next 10 years. I hope that makes as much sense to you as it does to me?

The next issue to consider is the cost of owning the property in different legal entities. The initial costs vary depending on whether you register the property in your own name [or your spouses]; or whether you set up a ‘corporate’ structure like a limited company [PTY LTD] or a close corporation [CC] or a Trust. There are a bunch of tax issues that seem to keep changing with the government becoming ever more hungry. There is transfer duty, estate duty, Capital Gains Tax [CGT], Secondary Tax on Companies [STC], executors fees – and that’s just a short summary!

Then there are the costs of changing ownership. The government would dearly love to charge you full transfer duty every time there is a tiny change in ownership. For example, if the home is held in a company and any shareholder dies – that triggers another 10% to SARS!

I am going to look at a few options in light of the above comments.

About the easiest way to register a property is in your own name, or jointly with your spouse. Transfer duty operates on a sliding scale, and for a less expensive property the initial transfer duty savings can be a significant percentage – when compared to registering in a PTY LTD, CC, or Trust. As the property gets closer to R1 million, however, the savings become almost negligible.

The real problems with a business owner registering property in a personal name occur when either of 2 bad scenarios play out. On attack by business creditors in a business failure scenario [96% of startups fail in the first 10 years] the house can be attached in execution of a judgment. This is an issue we looked at in some detail earlier. On death, CGT is levied – and the estate must pay for this as the property is transferred to the spouse. Both of these are bad.

Many of us have our homes registered in the names of CCs. This used to be a fun way to avoid paying transfer duty when selling the property. It isn’t any longer! As soon as the membership of a CC changes – no matter what the reason, and no matter how small the change – another 10% transfer duty is levied. [That 10% transfer duty is the standard for transfer to any corporate entity – be it a CC, PTY LTD or a Trust.]

This would happen, for example if you wanted to sell the CC, or introduce another member, or any member died, or a members share was attached in execution of a judgment.

In addition, CGT is levied at the time of the change. And finally, should there be any profit from the sale, STC is levied on the profit distributed to the members! Many of us are stuck with this structure, but there is absolutely no reason on earth to put any residential property into a CC in future. [At least not until the tax rules change.]

A CC does offer a degree of compartmentalisation as discussed above – but the members interest (shareholding) is just another asset in the hands of the business owner. This means that it can be sold in execution of a judgment. (The fact that the member has signed a surety covering the mortgage on the underlying property compounds the catastrophe remarkably.)

Everything I mentioned above regarding CCs applies to properties registered in PTY LTDs as well. Except that PTY LTDs also need a Chartered Accountant to sign off the audited books. They are thus a more expensive route than CCs.

All of this means that having a residential property registered in a CC or PTY LTD is much worse than having that same property registered in the name of an individual.

Which leaves us with the controversial Trust as the best option. I’d like to look at it in some detail because it holds quite a few hidden benefits that are not immediately obvious. For the rest of this article I will refer to this property holding Trust as a Property Trust, to distinguish it from a Family Trust [the Trust which holds your furniture, life savings, and other unencumbered assets].

The most important benefit – by miles – is the compartmentalisation issue. A property held in a Trust is completely safe from business creditors (or any other disastrous group or circumstance) even though the entrepreneur may have signed hundreds of sureties. Since the property is not held in your personal name, it simply cannot be attached. This means that you can enjoy all the benefits of the property without the burden of ownership.

The cost of initially transferring the property into a Property Trust is a flat 10% transfer duty. This is marginally higher than the costs for an individual to own the property – and the gap narrows the higher the price of the property purchased.

Unlike a PTY LTD which needs a CA to audit the books, or a CC which needs an accounting officer to sign off the books, a Property Trust simply needs to submit an annual tax return. This makes the running costs somewhat lower.

Next, the death of an individual has no effect on transfer duty, since the Property Trust does not die when any individual does. Nor is there any transfer duty when a trustee or beneficiary changes. This ensures that CGT does not kick in on death.

CGT does kick in when the property is sold out of the Property Trust, but the ‘conduit’ principle means that CGT can be taxed in the hands of each individual beneficiary – at the marginal tax rate of that individual – even though the CGT rate for any Trust is usually a flat 20%.

May I suggest that the ideal structure to own residential property would be a Property Trust, structured so that the beneficiary of that Trust is your Family Trust? This ensures that themortgage bond for the property does not endanger all the other assets in the Family Trust– which should ideally only hold unencumbered assets. This structure allows you to keep the property within the safety of the Family Trust, without endangering the Family Trust in any way.

Any growth in the value of the asset is held within the Family Trust, and when CGT is finally levied on sale – that CGT is taxed at individual marginal rates of the ultimate beneficiaries – the beneficiaries of the Family Trust!

Since Trusts form such an integral part of any entrepreneurs structure, I have been recommending them for years – despite opposition from most professionals who persist in the myth that the “law is about to change.” Indeed the law has changed, and will continue to change. But over the past decade, each change has helped those who already have a Trust, while making it a little more uncomfortable for those who don’t. Trust ‘owners’ are much, much better off than entrepreneurs without Trusts.