Trust Structures for IPs and Shares

Hi everyone

Just wondering how many of you use trusts for holding IPs and shares, and what type of trust structures are most popular.

I have no IPs or shares yet but I have been researching property for the past couple of years (since I bought my PPOR 2 years ago) - have read all the good books... Spann, Somers, Yardney, API magazine etc. Got my initial inspiration from one of Peter Spann's books and just kept reading! So now I'm ready to start investing!

Planning to buy 1st IP in the next few months and will continue investing in property (and later shares/LPTs when I learn a bit more about them) for the forseeable future, with a plan to retire in 12 years (from the day job, I'll keep investing) with the ability to Live On Equity / Passive Income from a large Property and Share portfolio thereafter. My wife and I are on reasonable incomes with no kids (yet) so our serviceability is pretty good. Aiming to have at least $15M to $20M in property and shares by 12 years time, with $4M+ or so in equity, which should be plenty for LOE, and I'll always keep a big LVR buffer there for emergencies, and keep investing of course.

So I want to get appropriate trust structures in place for all of this first!

I want the trust structure for asset protection, future flexibility and estate planning. I expect to always be negatively geared overall (as per the LOE plan), so income streaming is not an issue for the trust that holds my negatively geared property - it will always be negative.

So after that lengthy introduction, now my questions!

1. I'm thinking about a Chan & Naylor Property Investor Trust for the properties. I understand this uses a Unit Trust / Hybrid Discretionary Trust structure. Does anybody else have experience with this one?

2. How many properties should I put in one trust before I get a second trust. The IPs I'm initially planning to buy will be median price (houses, not units) in high capital growth Northern Beaches areas - i.e. $800K+ properties.

3. For the shares/LPTs, I'm thinking a normal discretionary trust, that can eventually feed extra income into the negatively geared HDT. Would this be the right structure. Should I use different trusts for different share portfolios?

4. Are the 'big-5' banks, Westpac etc., OK with Unit Trust / HDT structures for property investing? Do they understand these structures or will I have to spend ages explaining how it works.

5. Will this structure allow me to capitalise interest on my IP properties, and is this capitalised interest tax deductible for the next 12 years that I plan to continue working. Of course, once my LOE period starts then I won't be paying any tax in the first place.

6. Can I sell my PPOR to the trust in the future and therefore convert it to an IP, freeing up cash to buy a new PPOR. Can I sell it for any price, or does it have to be 'market value' - i.e. assessed by valuer etc? I understand this would incur stamp duty.

7. Should I use the same company trustee for all the trusts, or a different company for each trust.

Sorry about the long post and all the questions, but there are so many knowledgeable people on this forum that I'm bound to get some good advice!

Thanks!

Shadow.

Shadow said:

Hi everyone

2. How many properties should I put in one trust before I get a second trust. The IPs I'm initially planning to buy will be median price (houses, not units) in high capital growth Northern Beaches areas - i.e. $800K+ properties.

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There are a few issues here. Land tax, asset protection, and I also think costs of trust accounting/admin.

I assume if you are purchasing 800K+ houses, land component would be quite high. I am not very familiar with NSW land tax (have only looked at victoria) but I just had a quick browse on the NSW OSR site.

Looking on the OSR website it seems that its a flat 1.7% tax for individuals, above the 352K threshold, but trusts do not have the benefit of this level (please somebody correct me if I am wrong!) if they are "special trusts''.

Special trusts = a trust with a discretionary element:

http://www.osr.nsw.gov.au/pls/portal/docs/page/downloads/other/lt_booklet_2007.pdf

If that is the case then I assume that adding more trusts will not reduce land tax (as the 352K exemption per trust will not apply).

(somebody please correct me if I have this wrong!)

As for asset protection/costs of trusts - I guess thats a pretty individual question.

Shadow said:

3. For the shares/LPTs, I'm thinking a normal discretionary trust, that can eventually feed extra income into the negatively geared HDT. Would this be the right structure. Should I use different trusts for different share portfolios?

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I believe its best to seperate IP trusts (ie assets with a residual legal risk) from shares/LPTs (assets with no legal risk).

Dont see why you would wish to use different trusts for different share portfolios.

As for feeding income in between trusts - this can be done - but as Mry pointed out an a recent thread there may need to be family trust elections and intersposed entity elections made. Not sure what impact this has on creating new trusts down the line???

Shadow said:

7. Should I use the same company trustee for all the trusts, or a different company for each trust.

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Different company is usually recommended from what I have read.


Sorry I dont know the answers to your other questions but Im sure others will help!

NSW land tax is sucky because it doesn't give thresholds to trusts. Queensland, for example, does give a $300k threshold.

Shadow, how much income must have you have to support a mortgage on a $800k property? Would it make more sense to spread your investments by buying cheaper properties in different states to get the land tax exemptions?

Have you spoken to a mortgage broker about your borrowing capacity and whether your income will continue to allow you to buy such expensive IPs?
Alex

It does seem sucky in NSW regarding the land tax alex.

When initially putting together a structure for future investments (when one wants to move past investing in ones own name) - what is the normal procedure?

I.e. after documenting what you propose to do - first check with:

Mortgage broker to make sure banks will lend to proposed structures
Accountant - to make sure the tax works the way one expects
Lawyer - is this needed - or does the accountant do all this?

I would imagine changes would often need to be made after speaking to two (or three) of the above?

Hi Alex,

We have enough equity in our PPOR to get the first $800-900K IP now, and between my wife & myself, our servicability is pretty good... we can finance about $2M worth of debt at this stage, which will cover planned purchases for the next year or so. After that, I will look to Cashbonds. LPTs or high-dividend paying shares to improve servicability.

Need to educate myself more on that area (funds&shares), but I don't think it's the right time to get into shares right now, I'll wait for the big stock market crash... I think that's coming up within the next two years Which should be just about the time my servicability runs out

But I'm also researching ways to use debt to service debt. From the reports I read (Residex etc) most Northern Beaches suburbs are forecasting 10%+ per annum growth for the next 5 years, and it's an area I know well, so I should be able to pick some bargains. I'm also too lazy to travel and research other states so I'm going to stick with this area, at least for a few years. The growth should help me keep buying by capitalising some interest, keeping LVR around 80%, and using Cashbonds for more income if required.

That's the current plan anyway, but I'm always open to new suggestions and new ways to do things. This forum has been invaluable and has really helped me define my strategy.

Cheers,

Shadow.

alexlee said:

NSW land tax is sucky because it doesn't give thresholds to trusts. Queensland, for example, does give a $300k threshold. ... Alex

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Actually as of the recent QLD budget the threshold for trusts is now $350K I was most pleased as every time I approach the threshold the Govt keeps raising it.

cheers

Shadow said:

1. I'm thinking about a Chan & Naylor Property Investor Trust for the properties. ...Does anybody else have experience with this one?

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Of all the online discussions on this trust, I can only recall one person ever saying they are using the PIT. It'll be interesting to see what this poll shows though. I'm not sure how successful or unsuccessful the PIT has been for C&N. Personally, I wouldn't touch it at all. I think you're best bet with trusts/structuring is to make an appointment with Chris Batten and talk to him directly about your situation and cop the fees for it! Also, register on his website to get more detailed reading material on trusts/structuring.

GSJ

GSJ said:

I'm not sure how successful or unsuccessful the PIT has been for C&N. Personally, I wouldn't touch it at all. GSJ

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Hi GSJ,

Yes, interesting to see nobody has selected PIT yet...

I'm also interested to hear why you wouldn't touch it?

Do you use other trusts yourself?

There was some discussion in earlier threads suggesting that Chris Batten was reviewing his HDT with the ATO and was expecting an definitive answer in a few weeks regarding whether the structure was acceptable (that was about 5 months ago now!). Has anybody heard anything on this?

Cheers,

Shadow.

Shadow said:

I'm also interested to hear why you wouldn't touch it?

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Hi Shadow,

If you haven't already, you should read this thread which will give you some idea:

http://www.somersoft.com/forums/showthread.php?t=24292&highlight=Property+Investor+Trust

I don't know if there have been any modifications to the PIT recently, but last time I checked it did in some aspects seem to be pushing the bounds of what could be acceptable to the ATO. Given recent PBR's on HDT's this seems even more so.

GSJ

Hmmm, yes I read that thread before... to me it sounded like Chris was simply denigrating a competitors trust structure... and Chan& Naylor have refuted the allegations reasonably well on their website.

Chris has not provided any update on his discussions with the ATO yet, which has me slightly concerned about the MGS HDT too... personally I think both structures are probably quite similar in the eyes of the ATO, and if the ATO passes one then it will pass the other.

Unless somebody here can point out a significant difference between them?

Still no votes for the PIT though... I would really like to hear from somebody who uses it.

Shadow, given that the ATO hasn't given a definitive answer / judgement on either of those (though I have seen specific rulings limiting deductions on some HDTs), what value would users' opinions have at this stage? Even if someone said 'I use a PIT or other HDT and it works really well for me' what would that prove? Not much, since the ATO hasn't ruled on it. In the case of an audit the ATO may allow it or it might not. If the latter, all the positive user reviews aren't worth anything. If the former, all the negative user reviews (though I doubt I would complain about using a HDT unless the ATO disallows my deductions) wouldn't mean anything either.

This is a legal structure, not a car. We're not talking ease of use, and performance is up in the air until the almighty ATO has given it the green light.

As an aside, I don't use trusts yet but plan to set up a standard discretionary trust.
Alex

Shadow said:

... and Chan& Naylor have refuted the allegations reasonably well on their website.

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Really? I had a look on their website but didn't think there was much of substance there. Maybe if you are a client/member you would get access to more info.?

... I would really like to hear from somebody who uses it.

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So would I! - I have asked this question several times before on this forum but no-one here seems to be using it...or is admitting to it?!

GSJ

Hi Alex,

I just want as much info as possible before making any decision - this is why I am interested in comments from PIT users.

Actually I have investigated HDT structures quite closely. The PIT is just another type of HDT with a different name. There really is no issue with the 'structure' ... it is what people do with it that can cause concern.

For the ATO to have any case, they need to prove that tax was avoided. With the HDT, you basically just negatively gear, and receive the same tax deduction as someone who has bought IPs in their own name. Therefore you have not avoided paying any tax, since the alternative - i.e. owning property in your own name, would result in exactly the same tax payment.

However, after the properties become positively geared, what some people do is they redeem the units in the HDT at the original cost, thereby avoiding capital gains tax. At this point they use the discretionary part of the trust to stream income. That is the part that the ATO have an issue with - the avoidance of capital gains tax on the redemption of units.

But there are ways around this problem...

1. When the IPs become positively geared, redeem the units at present value, based on the IP property value increase, and pay capital gains tax on the sale. Then there is no problem with streaming income from the IP.

2. When the IPs become positively geared, pass all the income to the unit holder. This may be acceptable if the user sees no benefit to discretionary income streaming in their individual case.

3. Never redeem the units, and instead keep the IPs negatively geared (by buying more IPs and Living on Equity).

So... if used correctly, the ATO cannot complain about the HDT, because the user has not avoided paying tax compared to the alternative option - i.e. owning in your own name.

The benefit to the user is flexibility... you have the options 1, 2 and 3 above, you also gain some degree of asset protection, and estate planning becomes easier.

Having said all that, if you plan to LOE and never have a positively geared portfolio, and if asset protection and estate planning are not big issues, then there is no major benefit to a HDT structure. You might as well just buy IPs in your own name.

This is something I am still trying to decide on... since I do plan to LOE, so I dont really need a HDT, unless I consider asset protection to be very important (I consider it reasonably important, but not vital, since I'm not in a high risk occupation). Asset protection in a HDT is not as good as in a discretionary trust, because the units could be claimed by a creditor, which is a problem if it is considered that the unit's value grows in line with the IPs capital gain.

However, I would like the flexibility to change my strategy in the future, in which case it would be sensible to set up a structure that allows such flexibility, even if I never use it. The cost to set up the trust structure is just a few K... insignificant compared to the property values, so there's no harm in setting it up this way from the beginning, just in case that flexibility is ever required. And just to repeat what I said above... the ATO needs to prove that tax was avoided before they can claim this is a tax avoidance scheme. If the HDT structure is used correcty then no tax is avoided compared to buying in your own name.

Just wondering Alex... you say you plan to set up a discretionary trust... I assume this would be for positively geared IPs or shares? (since you can't negative gear a discretionary trust).

Cheers,

Shadow.

Shadow, if you read the threads on HDTs, you'll see that we've already debated at some length what you've just said. We didn't come to any conclusion because none of us are the Tax Commissioner! Also have a read of some of the ATO rulings AGAINST HDTs. What they seem to say is that the loan taken out in your personal name does not have sufficient benefit to allow full deduction.

Also (and this is just my theory since there is no case law on this either) I wonder whether the ATO would allow redemption of units at cost the way some HDT providers state. If not, does that mean units have to be redeemed at market, in which case how would the units be valued in, say, a bankruptcy case? (i.e. will you lose the asset protection aspect?)

I'm not from the ATO, nor am I a tax expert, though I am an accountant. I realise that there is a chance these HDTs may all be ok from the ATO's point of view. I just think this is a new product that doesn't have much case law behind it.

When you think about it, can you really justify full deductions for an ordinary IP held in a trust or personal name? Losses can continue for years. But it IS allowed not necessarily because of tax principles but because of historical case law. Same with family trusts, really. If I am in a position with very little chance of litigation, what possible motive could I have for putting assets into a FT except for tax minimisation? Usually that wouldn't be allowed, but history (and the fact that so many rich people and pollies use FTs) would skew the ATO on this politically.

When they considered changing taxation of trusts to be more like companies, there was a lot of media brouhaha. I haven't seen anything about HDTs in the mainstream papers.

The ATO argues on technicalities as well as principles. It'll use whatever means it can to maximise tax receipts. I don't understand enough of the politics of the ATO and the courts to make an assessment on how they will decide / rule on this.
Alex

Shadow said:

Just wondering Alex... you say you plan to set up a discretionary trust... I assume this would be for positively geared IPs or shares? (since you can't negative gear a discretionary trust).

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Not exactly. You CAN have a family trust in a net loss position and carry forward that loss. You just can't distribute the losses. I figure in time I'll develop businesses and so on that will have positive income that I can use to offset the losses. Or just wait until the IPs themselves become positive.

I'll be using the FT for IPs that will initially be negatively geared. I'm willing to take the initial 'loss' of not being able to claim all the deductions now to get the future income streaming and asset protection advantages. Separate FT for shares, since I have a non-working partner ("I buy the house, you provide the tax shelter, dear....").
Alex

alexlee said:

We didn't come to any conclusion because none of us are the Tax Commissioner!

....

Like the rest of us, I would think the only thing you're missing is the ATO's stamp of approval.

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Yes, basically I think that is the bottom line. The trust/tax experts here don't agree on this one anyway.

alexlee said:

What they seem to say is that the loan taken out in your personal name does not have sufficient benefit to allow full deduction.

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Though there is no formal ATO stamp of approval OR disapproval on this - there is one PBR which suggests that the interest should be deductible, and the ITAA also agrees with this view. Further, the ATO have reviewed individual cases on this and have had no problem with interest deductibility. Also, in theory, using the HDT to negatively gear (with an appropriately worded trust deed - and most of the PBR's had quite obviously poorly worded trust deeds, even to the layman!) is exactly the same as buying in your own name. I think even its harshest critics (and I would include myself as one of these!) would admit that. It is only, as Shadow correctly states, that when redemption occurs that issues/problems may arise.

I would have to agree with Shadow's overall assessment, but yes Alex, I also appreciate that we have still not heard anything more concrete from the ATO to put all this conjecture to rest (at least on this public forum!)...

ADD: Still 0 for C&N.

GSJ

Shadow said:

From the reports I read (Residex etc) most Northern Beaches suburbs are forecasting 10%+ per annum growth for the next 5 years, and it's an area I know well, so I should be able to pick some bargains. I'm also too lazy to travel and research other states so I'm going to stick with this area, at least for a few years. The growth should help me keep buying by capitalising some interest, keeping LVR around 80%, and using Cashbonds for more income if required.

That's the current plan anyway, but I'm always open to new suggestions and new ways to do things. This forum has been invaluable and has really helped me define my strategy.

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Mate,

We really should catch up for a coffee!!

I'm a Northern Beaches bloke myself and it sounds like your servicability etc puts our situations very much on the same level. I've got my first IP ($700K) in Mona Vale which I'm now in the process of developing into three boutique townhouses/units worth about $830K each.

I'm a bit fatter in shares than you plan on being though. I've got $800K working over there right now bringing home about 20% per annum which more than covers my 8% cost of capital.

Anyway, off topic, but hollar if you want to catch up some time or maybe just swap some PMs. Always happy to chat to other Northern Beaches investors and it seems to be a growing sub-set of this forum...

Oh yeah, and I have an HDT with company as trustee structure which currently has my IP and shares all in it. I might look to split it in two so I have the CF+ in one and the NG in the other, but all the stuff going on with the ATO at the moment over HDTs passing NG deductions out of the structure makes me wonder about the benefit of doing so. Not really phased as the structure is still doing its job of arms length asset protection.

Cheers,
Michael.

PS This is not a pump and dump post for my Mona Vale IP or my Nth Narra PPOR! Declaration: I hold and intend to keep doing so...

GSJ said:

the ITAA also agrees with this view

GSJ

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Sorry, I think I meant NTAA?! I can't quite remember the abbreviation.

GSJ

MichaelWhyte said:

Mate,

We really should catch up for a coffee!!

I'm a Northern Beaches bloke myself and it sounds like your servicability etc puts our situations very much on the same level. I've got my first IP ($700K) in Mona Vale which I'm now in the process of developing into three boutique townhouses/units worth about $830K each.

I'm a bit fatter in shares than you plan on being though. I've got $800K working over there right now bringing home about 20% per annum which more than covers my 8% cost of capital.

Anyway, off topic, but hollar if you want to catch up some time or maybe just swap some PMs. Always happy to chat to other Northern Beaches investors and it seems to be a growing sub-set of this forum...

Oh yeah, and I have an HDT with company as trustee structure which currently has my IP and shares all in it. I might look to split it in two so I have the CF+ in one and the NG in the other, but all the stuff going on with the ATO at the moment over HDTs passing NG deductions out of the structure makes me wonder about the benefit of doing so. Not really phased as the structure is still doing its job of arms length asset protection.

Cheers,
Michael.

PS This is not a pump and dump post for my Mona Vale IP or my Nth Narra PPOR! Declaration: I hold and intend to keep doing so...

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Hi Michael,

Yes, I have read through your threads on the Mona Vale development before, you seem to have a great project going there

How did you go with that troublemaker who was objecting to your development

Looking forward to the the next update in your Mona Vale thread!

I will also consider development projects in a couple of years, once I have some investment experience under my belt. Also plan to get into shares, but not for another few years.

Will PM you about the coffee!

Cheers, Shadow.

What does this mean? Please advise.
"
I use a Maquarie Group Service (MGS) HDT
"

I am currently exploring a Trust structure for my investment. Does it mean I buy this MGS HDT from Macquaire? or an account can sell it to me?

Please advise, much appreciated.