Living on Equity of Trust owned Property

[MasterInvestor]

Hi

I just received my copy of Kevin Young's (of investor club fame) new book.

I must say it is rather disappointing, but one comment he made caused me to think.

He states that if a property is purchased using a trust or company, then you are not able to increase the loan on this property to live off the equity.

I would have thought so to be so regarding comapnies, but not necessarily trusts - especially a trust with a non corporate trustee.

So my question is, would it be possible to increase the loan on an IP owned by your discretionary trust with a personal trustee, and use this money to live on? If so, how would it be treated? Would it be a loan to the beneificary? What tax consequnces would this have?

Many thanks in advance.

Master Investor.

[DaleGG]

Hi

Yes, it is possible for the trustee to increase the borrowings inside a trust to use for the beneficiaries of the trust. Essentially, the trustee replaces one loan (with the beneficiaries) with a another loan (with the bank).

However, I also note that the tax office have released a ruling (TR 2005/D4 which replaces TR 2003/9) where they argue that there should be a number of issues dealt with before interest on the loan would be deductible.

To keep things simple for now...yes, the idea is possible, however, it may get harder and the real answer will depend upon the exact circumstances within each trust.

Dale

[XBenX]

Hrmmm interesting update Dale, thanks for that.

[MasterInvestor]

Thank you for that Dale.

However, what if the trust is not repaying a loan by the trustee?

eg. I lend $20,000 to my trust, and it buys a house for $100,000 using an 80% loan of $160,000. In seven-ten years the property may be worth $320,000. I then increase the loan to 80% of $320,000 or $256,000. This is an increase of $96,000. I assume $20,000 could be just the straight forward returning of the original loan to the trust. Now what about the remaining $76,000. How would this be accounted for?

This money would be used to live on, so the interest would not be deductible.

This is following the strategy promoted by the Investor's Club whereby you buy seven houses, one per year, then in year 8 you increase the loan to use to live on. In year 9 you increase the loan on the 2nd proeprty, and so on. By the time you reach property one again, it has doubled in value.

[Aceyducey]

eg. I lend $20,000 to my trust, and it buys a house for $100,000 using an 80% loan of $160,000.

???

80% loan is $80,000.

And then you have purchase costs on top (if in Australia).....

Investor Club method works OK in an ideal world if you buy the right properties in the right places (ie: perfect foresight).

In reality, make sure you have contingencies for the non-smooth years and property purchases that don't perform as expected.

Keep in mind that if you live off the equity it's hard to make all the interest tax-deductible - but that you don't pay tax on the equiy drawing.

And be cautious buying the properties from the people telling you the strategy you should use! :)

Cheers,

Aceyducey

[DaleGG]

Hi

I'm a simple person so I always try to take things back to the basics....that way, I have some chance of understanding them myself!

For interest to be tax deductible, the borrowing must have been for an income produing purpose. So, if the trust just borrows money to use to provide "living" money to a beneficiary, then, the interest is unlikely to be tax deductible because the purpose of the borrowing was not for income producing purposes.

However, if the trust borrows money to meets its obligations and pay the bills of the trust then interest on that borrowing should be tax deductible. And, if the bills of the trust are a variety of day to day costs that inlude rates, insyrance etc then that is easily done, too.

But, if the costs include paying for expenses of the trust that might have replaced some of your private costs then this, too, should also be tax deductible.

Lastly, please remember that a trust distributes its income each year. So, if your property has made a profit and that profit is distributed to you as a book entry, then, your loan account with the tust has increased each year. This brings me back to my original post.

The issue is very much under discussion at the moment and we may have a clearer position later in the year where comments can be more accurate. In the meantime, rehgardless of what I say, or anyone else says, it will be you and your accountants decision how the law can be applied to you and whether or not you wish to go down this road.

Have fun

Dale