One of the benefits of a negatively geared property investment is the ability to deduct the losses incurred against other income. For this reason many investors register property investments in their individual names. Although this achieves their tax objective it does not provide tax flexibility nor asset protection objectives, which are available in a trust structure. It’s worth gaining a good understanding of the pros and cons of a trust structure before making the decision.
If a trust is the best structure for your situation then we recommend that you set one up sooner rather than later. To transfer a property into a trust at a later date can attract unnecessary costs. The longer you leave it the higher the growth, which results in more stamp duty and capital gains tax when transferring the property.
If a trust is the best structure, the next question will be – what type of trust? The type you choose will depend on your personal situation.
Distribution of Income
Income from a trust can be distributed in a tax efficient way. The trustee of the trust has the discretion to distribute income to any of the trust beneficiaries. Ideally income would be distributed to family members with the lowest taxable income and hence the lower tax bracket. This can be varied annually depending on family circumstances.
Trust income can also be distributed to children under 18, but only up to $1,325 per child for the 2008 year, after which income is taxed at the highest marginal rate.
Note that if the property is negatively geared (i.e. costs exceed income) then the tax losses would be carried forward in the trust and utilised in future years when profits are made. Under a negatively geared situation unit trusts or hybrid trusts may be more appropriate, where the losses can be regularly utilised.
Capital Gains Tax
When the property is eventually sold the trustee can choose which beneficiary will receive the capital gain. This could save large amounts of tax by allocating these gains to the beneficiary with the lowest tax rate. Investment properties that are held for more than a year will be eligible for a 50% discount on the taxable capital gain.
If you purchase a property in a trust then in theory it would be protected if you were sued. In many instances insurance covers the costs of unforeseen events – but there are many situations where insurance does not pay out.
A trust also offers an extra protection – if you lend money to a trust then the loan is at risk, therefore, it is preferable to make a gift of money to the trust from an asset protection point of view. Your creditors can then only gain access to trust income that has been formally distributed to you i.e. income that you are entitled to receive.
If the property is negatively geared and you intend to keep it that way for some time then a discretionary trust may not be for you. Any losses incurred get stuck in the trust. Under these circumstances you may consider a unit trust or hybrid trust, where you can get the benefit of the losses on an ongoing basis. With these trusts you would borrow from the bank in your own name and purchase units in the trust. With the loan in your name you can set the interest costs off against your other personal income, provided that the trust deed provides for distribution of all the income from the property to yourself.
There will be upfront costs relating to the set up of the trust. In most cases we would recommend that the trustee of the trust be a company, which will add to the upfront costs.
Ongoing costs include accounting fees and ASIC fees if a corporate trustee is chosen.
In many states land tax will be at higher rates in a trust than in an individual’s name.
Questions To Ask Your Accountant Or Lawyer
If you own or intend to own an investment property, we recommend that you seek advice from your accountant or lawyer about the best structure for your situation. We recommend asking them the following questions in respect of trusts:
- What are the benefits of using a corporate trustee?
- What are the potential tax savings from a trust structure?
- What type of trust is best for my situation?
- Who should the beneficiaries be, and why?
- Who should the appointers and settlor be?
- How much control will I have over “my” property?
- How can I ensure that the loan is deductible outside of the trust?
- How much will it cost to setup and administer a trust?
As every situation is different, the information contained in this newsletter is for informative purposes only and should not be used as advice in structuring your investment properties.
We are happy to assist investors or potential investors with setting up an efficient structure for their purposes.