Chan & Naylor - PIT trust

What then happens when the trust later sells the property? Is the cost base for CGT still the original purchase price of the property or the price the units were redeemed for? If the former, then CGT will effectively be paid twice on the same gain.

Good question. Would be interesting to find out the answer. Common sense says it should be the value you redeemed your units at. But who knows there are a lot of things where they don't work according to common sense.

Cheers,
Oracle.
 
Hi Guys

“So how do you guys value income units at redemption time? cost + inflation? NPV?”

At market value. So if the Assets of the Trust are predominantly property than its whatever the market value of the property is that will determine the value of the Units in the trust.

So there's no benefit at all with this structure in terms of streaming income once the investment is positively geared, compared to purchasing the property in your own name...is that correct?

Other than being able to find a valuer who will give you a very conservative valuation of the property?

And maybe, no stamp duty on redemption of units?

Thanks.
 
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Bianca,


So if the unitholder redeems the units when the property has increased in value, then he will pay CGT on the gain.

What then happens when the trust later sells the property? Is the cost base for CGT still the original purchase price of the property or the price the units were redeemed for? If the former, then CGT will effectively be paid twice on the same gain.

Thanks.

GP

If you sell your units in a trust that itself has an unrealised capital gain then you have merely realised your share.

When the trust sells the asset, it distributes a CG and the value of the trust falls.

Anybody subsequently selling will make less of a gain or even a loss on the unit itself.

The really big problems with unit trusts are:

1) Any income or capital cannot be streamed

2) Any tax deferred distributions such as building allowances reduce the cost base and even cause a capital gain.

These problems don't exist with a DT.

Surely these points were explained to people BEFORE they decided on the HDT/unit approach to holding property for investment ??????

Cheers,

Rob
 
Rob,

If you sell your units in a trust that itself has an unrealised capital gain then you have merely realised your share.

When the trust sells the asset, it distributes a CG and the value of the trust falls.

Anybody subsequently selling will make less of a gain or even a loss on the unit itself.
Sorry, I don't quite follow. If "my" share was 100%, does that mean the cost base of the asset increases to the price the units were redeemed for?

Take this example: an HDT is established and $500K of units are purchased. A $500K property is then purchased by the trust (ignoring costs for simplicity). Fast forward 10 years and the property is valued at $1m. The unitholder wants to redeem the units so that income can go to someone else. He redeems for $1m and gets an IOU from the trust for that amount (since the trust doesn't have any cash). He pays tax on $250K, being 50% of the profit. Shortly afterwards, for whatever reason, the trust needs to sell the property and gets $1m (again ignoring costs).

Now the question is, what profit gets distributed to a (let's say the same) beneficiary - $500K or none?

If it's $500K, then presumably that beneficiary would have to pay tax on $250K of the profit a second time, and the trust would have $1m in assets (cash) but owe the beneficiary $1.5m ($1m for the unit redemption and $500K for the profit distribution. Where would it get the funds? The trust would effectively be bankrupt with a debt of $500K.

GP
 
Not a good example if no beneficiaries are left !

Terminating distribution could be the property in-specie.

Or the Trustee could sell the asset and distribute the proceeds - the distribution will be pregnant with the net capital gain of the asset realisation.

Cheers,

Rob
 
the distribution will be pregnant with the net capital gain of the asset realisation
Hmm... I take that to be a fancy way of saying the cost base will be the original purchase price, and thus my example is correct with the profit distribution on sale being $500K.

GP
 
Hmm... I take that to be a fancy way of saying the cost base will be the original purchase price, and thus my example is correct with the profit distribution on sale being $500K.

GP

Sell the asset = $1m in piggybank

But liability to unit holder for the $500k statutory income (gain) on which they will be assessed

Market value of unit is the net asset value of $500k in cash

There is no double application of CGT, first by the Trustee then by the beneficiary. It is merely attributed to the beneficiary.

Cheers,

Rob
 
Rob,

But what if the units are redeemed before the asset is sold, which is the primary point of my question and example.

GP
 
Rob,

But what if the units are redeemed before the asset is sold, which is the primary point of my question and example.

GP

I presume you mean a HDT redeems all units and then holds the property for the discretionary beneficiaries.

This is where you sit on the bleeding edge of technology and the rest of us that have yet to be convinced as to the legality or logic sit by and observe with great interest.

There is no precedent from unit trusts as this cannot happen - the trust ceases when beneficiaries cease !!!

Assuming the trust deed is robust enough not to constitute a resettlement on a new (sub) trust, there appears no strong argument that the cost base should be reset to market value.

You seem to be stuck in no man's land with inconsistent views for CGT. Where a beneficiary has an interest in the trust (e.g. a unit) then this is a CGT asset by itself. This is what incurs CGT on redemption even though the underlying asset has not been realised.

The Trustee already has legal title to the asset. The payment for redemption of units cannot reasonably be argued to be part of the 1st element of cost of acquisition. Nor can it be reasonably argued to be part the 5th element by improving/defending the quality of title since the Trustee has no beneficial interest in the trust asset, neither does the discretionary beneficiaries. I presume because market value has been used, no value shifting provisions can occur - besides discretionary beneficiaries have no interest.

The only comments I get are that the long term benefits of income splitting positive gearing outweigh the short term costs. Nobody has done a DCF analysis that I have seen which explicitly shows the CGT position.

Ask your Financial Planner whether the CGT is collected again in the form of the original cost base to the Trustee.

ALSO, will building allowances compound the problem as the unit holder might get CGT events E4 from distributions AND the cost base is reduced for the Trustee by the same amounts.

ALSO, will the CGT liability (including depreciation effects) be allowed to be factored into the market value for redemption ?

Cheers,

Rob
 
The only comments I get are that the long term benefits of income splitting positive gearing outweigh the short term costs. Nobody has done a DCF analysis that I have seen which explicitly shows the CGT position.

This is what kills HDTs for me. If I buy a house for $400,000 in a HDT, redeem it when it becomes positively geared at $750,000 and then sell it at $1mill, the unitholder pays tax on a capital gain of $175,000 (750-400/2) and later the beneficiaries of the HDT have to pay tax on a gain of $300,000 ($1mill-400,000). So on a gain of $600,000 net, you have to pay tax on $475,000. A person who owned the property in their own name would pay tax on $300,000.

Its easier to buy in your own name and sell it to a DT later. That would reset the cost base in the DT to $750,000 (stamp duty in QLD though would be an extra $26,225 at transfer time) but save you paying tax on $175,000.

Plus - 100% chance to negative gear and the refinancing principle still works.
 
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Rob,

This is where you sit on the bleeding edge of technology and the rest of us that have yet to be convinced as to the legality or logic sit by and observe with great interest.
Thanks for the explanation.

Hopefully I'll be part of that "rest of us" rather than the "you". :D

GP
 
Streaming Income

JIT wrote
“…So there's no benefit at all with this structure in terms of streaming income once the investment is positively geared, compared to purchasing the property in your own name...is that correct?...”

You can continue to stream your income as long as you have recognized there is a commercial transaction when you redeem your units such as declaring a capital gain versus the tax saved by streaming the income to a lower taxpayer.

For example if the tax saved by redeeming the units and streaming the income to a lower taxpayer was $100,000pa over many years (based on a tax rate of 46%) and you had to pay $10,000 in capital gains tax (with a 50% exemption for CGT thus reducing your tax rate to 23%) than you would consider it.

The Trust would achieve this streaming to a lower tax payer by refinancing the loan within the Trust and redeem the units to the unit holder and pay say $10,000 in capital gains tax but save $100,000 in income tax (as an example).

However you would need a commercial reason other than to minimise your tax position, so a good commercial reason would be to give the lower income earner an income so she or he could show serviceability in order to borrow funds in her own right for further investments or she may want to become independent showing income in her own tax return. A number of commercial reasons for redeeming units other than for tax reasons.

Once the units are redeemed the capital value sits in the Trust as a capital distribution for the future and this can be at the discretion of the Trustee because the Trust is now a Discretionary Trust since all the unit holders no longer exists. The positive rental (after interest is deducted because the loan now sits within the trust) can now be distributed to the lower taxpayer beneficiaries at the discretion of the Trustee.

Hence if the Units were bought for $400,000 (property also valued at $400,000) and redeemed at $700,000 (being deemed market value of units which may or may not be the market value of the property) a CGT on capital gain of $300,000 is payable but the cost base of the property in the Trust is now $700,000 so if the Trust were ever to sell the property at $1,000,000 than a capital gain of $300,000 can be distributed to any beneficiary which could include a person being the lowest taxpayer thus saving CGT.

If the units were redeemed at $700,000 but the market value of the property at the time was $800,000 than the Trust would have acquired a property at $700,000 and its cost base would be $700,000 even though the real property value was $800,000 hence having a lower cost base for the future and paying more CGT when the property is sold. There must be a commercial reason for redeeming units at $700,000 instead of $800,000. The commercial reason could be that the redemption of the income units were at a value less than the property value as the income units may not be valued at the same value as the property which includes 100% of all rights and benefits.

There are many other benefits with Hybrid Trust such as Estate Planning (you may want to pass assets to your children without any CGT and stamp duty or you may want to pass control of your assets to someone else without stamp duty and CGT ). You cannot do this if the property was in your own name.

Asset protection can even be achieved with units in a trust provided you have 2 trustees as the creditor is unable to force the other trustee to agree to redeem their units, unlike if the property were in ones own name.

There are many more creative ways of income streaming that has not been mentioned here but this cannot be done if property was held in ones own name.

There are also many ways to determine “market value” for example if you bought units in “GPT Property Trust” (a publicly listed Property Trust) you can buy units that only give you 2%pa growth and you can buy units that show more income than growth or more growth than income. Hence you can set up your Trust to do whatever as long as it resembles some form of commerciality when compared to what else is out there in the market place.

There are many more ways of creating flexibility in a Hybrid Trust than just buying in your own name.

Hope this helps

Regards
Bianca on behalf of
Chan & Naylor Accountants
www.chan-naylor.com.au
 
Bianca,

but the cost base of the property in the Trust is now $700,000
So you (meaning Chan & Naylor) believe that the cost base of the asset changes to be the redemption value of the units after redemption (assuming the asset has increased in value).

To me this makes sense, but seems to be contrary to what pretty much everyone else here has stated as being their belief.

GP
 
This is what kills HDTs for me. If I buy a house for $400,000 in a HDT, redeem it when it becomes positively geared at $750,000 and then sell it at $1mill, the unitholder pays tax on a capital gain of $175,000 (750-400/2) and later the beneficiaries of the HDT have to pay tax on a gain of $300,000 ($1mill-400,000). So on a gain of $600,000 net, you have to pay tax on $475,000. A person who owned the property in their own name would pay tax on $300,000.

Its easier to buy in your own name and sell it to a DT later. That would reset the cost base in the DT to $750,000 (stamp duty in QLD though would be an extra $26,225 at transfer time) but save you paying tax on $175,000.

Plus - 100% chance to negative gear and the refinancing principle still works.

Thx Mry, this makes sense to me. It is also what my accountant said (who owns quite a few properties). The trust side of things offers the protection against being sued I suppose.

Can someone pls comment on how trusts can be used to minimise tax via funnelling in to a Super Fund, vs buying IP's in my own name?
Thx,
JB
 
Hence if the Units were bought for $400,000 (property also valued at $400,000) and redeemed at $700,000 (being deemed market value of units which may or may not be the market value of the property) a CGT on capital gain of $300,000 is payable but the cost base of the property in the Trust is now $700,000 so if the Trust were ever to sell the property at $1,000,000 than a capital gain of $300,000 can be distributed to any beneficiary which could include a person being the lowest taxpayer thus saving CGT.

Regards
Bianca on behalf of
Chan & Naylor Accountants
www.chan-naylor.com.au


Appreciate your contributions thus far Bianca, it can become a warzone at times.

Can you clarify the cost base issue...from day 1, the trust is the owner of the property and has a cost base of $400k. I might be missing something, but can't see how this changes when a unitholder redeems their shares. The trust hasn't acquired anything at that time?
 
The cost base for the trust remains $400,000 no matter what the units are redeemed at.

A tax barrister's opinion on the value for redemption of units in a PIT or a HDT would be the value as they relate to the underlying value of the property. Any other value placed on redemption would be uncommercial especially as you are dealing with a related party.

Not my opinion but a highly regarded tax barrister.
 
Thx Mry, this makes sense to me. It is also what my accountant said (who owns quite a few properties). The trust side of things offers the protection against being sued I suppose.

Can someone pls comment on how trusts can be used to minimise tax via funnelling in to a Super Fund, vs buying IP's in my own name?
Thx,
JB

Just one point JB, if you redeem units in a HDT after a few flat years of capital growth but increases in yield, then you could potentially cop a small capital gain prepay some interest for that year, pay little tax then have the properties income and capital gain as discretionary in the future without the cost of stamp duty.
 
For example if the tax saved by redeeming the units and streaming the income to a lower taxpayer was $100,000pa over many years (based on a tax rate of 46%) and you had to pay $10,000 in capital gains tax (with a 50% exemption for CGT thus reducing your tax rate to 23%) than you would consider it.

OK, that makes sense.

so if the Trust were ever to sell the property at $1,000,000 than a capital gain of $300,000 can be distributed to any beneficiary which could include a person being the lowest taxpayer thus saving CGT.

Fair enough.

There must be a commercial reason for redeeming units at $700,000 instead of $800,000. The commercial reason could be that the redemption of the income units were at a value less than the property value as the income units may not be valued at the same value as the property which includes 100% of all rights and benefits.

This seems like an important point...but I don't quite understand what you mean, are you able to elaborate?

Do you mean something like the property owner ie. trust (with the ultimate rights/benefits) can renovate/develop the property, choose the tenant, set the rent, participate in body corporate decisions...where as the income unit holder cannot, and therefore at redemption time their units are valued at less (a little less, not hugely less, 'approximation') than the actual property's value??

There are many other benefits with Hybrid Trust such as Estate Planning (you may want to pass assets to your children without any CGT and stamp duty or you may want to pass control of your assets to someone else without stamp duty and CGT ). You cannot do this if the property was in your own name.

Fair enough.

Asset protection can even be achieved with units in a trust provided you have 2 trustees as the creditor is unable to force the other trustee to agree to redeem their units, unlike if the property were in ones own name.

If you have at present have just one trustee (eg. trustee company) can you add a second trustee, eg. an individual (not a company...to save fees)...? Could it be your solicitor?

There are many more creative ways of income streaming that has not been mentioned here but this cannot be done if property was held in ones own name.

But doesn't this mean creating tax advantages that wouldn't have been possible if you bought in your own name, and hence something to be frowned upon by the ATO?

There are also many ways to determine “market value” for example if you bought units in “GPT Property Trust” (a publicly listed Property Trust) you can buy units that only give you 2%pa growth and you can buy units that show more income than growth or more growth than income. Hence you can set up your Trust to do whatever as long as it resembles some form of commerciality when compared to what else is out there in the market place.

When redeeming units and valuing them do you go to a real estate agent or bank valuer and ask them to give you a conservative valuation?

Thanks for your reply.
 
Hence if the Units were bought for $400,000 (property also valued at $400,000) and redeemed at $700,000 (being deemed market value of units which may or may not be the market value of the property) a CGT on capital gain of $300,000 is payable but the cost base of the property in the Trust is now $700,000 so if the Trust were ever to sell the property at $1,000,000 than a capital gain of $300,000 can be distributed to any beneficiary which could include a person being the lowest taxpayer thus saving CGT.

Could you tell us where under tax law the cost base gets adjusted for the property in the trust? MGS talk about this in their recent brochure about the Taxpayer Alert

MGS said:
However, knowing these issues allows for planning to avoid what are sometimes unintended consequence. As with all types of unitised trusts, there is a potential double incidence of CGT with a Hybrid Discretionary Trust, which occurs when units are redeemed prior to the disposal of the underlying asset – CGT events occur when the units are redeemed as well as when the underlying asset is disposed of.
To me that reads that MGS are of the opinion that double CGT may be incurred on redemption and sale as I discussed in my example. Could you clarify this?
 
The cost base for the trust remains $400,000 no matter what the units are redeemed at.

A tax barrister's opinion on the value for redemption of units in a PIT or a HDT would be the value as they relate to the underlying value of the property. Any other value placed on redemption would be uncommercial especially as you are dealing with a related party.

Not my opinion but a highly regarded tax barrister.

I highly believe so. I do not believe what Bianca said - simply you can change the cost base because you are a related party. In other words, you can make up for avoiding the tax purpose. I have read Chan & book - legally reduce your tax. I do not find PIT is appropriate for most of investors here. It does have some benefit - estate planning and income distribution and protection. However, not many people are ready for PIT for this purpose. You have to take a big picture view - sell, NG, CGT, etc.
 
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