HDT explanation for Dummies???

[Shuttergirl]

HI all,

I've spent the last few weeks reading, reading, reading about the basics, things I need to know to purchase my first IP and a friend who has IP's said I had to have a HDT before moving ahead. That I would regret not doing it now.

I've read some threads and just can't get a grasp on it. It's stressing me out a little, I'm scared to move ahead without doing this but don't know why it is I should do it, hehe.......

Can anyone give me a very simple overview of the situation.

Thanks

Lisa

 

[Mry]

Not an easy question to answer off the bat, but I think it would be worth your while to read the NTAA article on their website about hybrids.

http://www.ntaa.com.au/media/associationatwork/usinghybridtrusts.html

You may want to read just the first half as the second half gets a little technical/boring for the layperson.

As the article mentions, there are some issues with HDTs that may not match the marketing material. I wrote an article about some of these issues here that I am still working on and haven't quite yet finished.

If you have access to old Property Investor Magazines, particularly the January and February 2007 issues, Dale Gatherum Goss covers the basics, but in August he wrote an warning about using hybrids. He also wrote a book Trust Magic on the issue.

While you will find the information you need from these links, sadly there are too many issues unsettled to make it clear whether a hybrid is safe to use or whether it is, in the NTAA's words, a 'tax nightmare'.

 

[JIT]

Interesting article Mry.

Seeing as DaleGG has retired, I don't think he's going to be coming on here posting his views on this anytime soon...but if he did that would be good .

I'm guessing that he would still say that an appropriately written trust deed is possible.

Still not quite sure why HDT proponents haven't got a Private Binding Ruling using their trust deeds???

And whether anything actually eventuated with Chris Batten's discussions with the ATO???

GSJ

 

[julia]

Dale has described the problems quiet fairly in August API the only thing missing is why, considering the requirements he set for a HDT to pass and ATO "review", would anyone bother to use a HDT.

 

[JamesGG]

Hiya,

Dale's articles on HDT's can also be downloaded from his website: www.trustmagic.com.au. The most recent one cannot be featured online until September, I am told.

Lisa, if you don't understand the concepts, then I would suggest that you really have two options; find out more (as you are attempting to do), or, leave them alone. This, I guess, depends on how much time and motivation you have in moving forward. I would certainly not recommend jumping in headfirst and finding out how deep the water is later, so if the whole idea is bothering you... perhaps best to run with the second option.

Dale has described the problems quiet fairly in August API the only thing missing is why, considering the requirements he set for a HDT to pass and ATO "review", would anyone bother to use a HDT.

Julia, I am sure that you know the benefits of using a HDT, and Dale's article in the August issue (written some months ago now, might I add) quite clearly states that the right deeds will allow these benefits to arise. The article is simply about warning investors with poorly written deeds or receiving incorrect advice, that they do need to be careful. Dale's last paragraph of the article essentially sums it all up:

Hybrid trusts aren't dead, as some misinformed people have claimed, but the authors of trust deeds do have to be smarter...

Cheers

James.

 

[Mry]

Still not quite sure why HDT proponents haven't got a Private Binding Ruling using their trust deeds???

And to be honest I'm getting a bit sick of continually coming back to this issue because of all the questions I keep getting about hybrids when hybrid sellers could solve this issue easily.

Its not that hard to get a PBR on a hybrid trust on the cheap. Borrow $5,000 on personal loan rates, put it in a trust, buy shares in the trust, do a projection on the earnings and then send the deed, the paperwork, the expected income and the expected deductions to the ATO. Wait for your reply. Then redeem the units, send your methodology to the ATO, and await a reply. Then sell the shares, distribute the capital gain to another party, apply for a 3rd PBR and wait for a reply. Pass all three, test it with two other people, proclaim to the world your compliant deed with the PBRs to view and you might get some business.

After all I have looked at, I just see too many inherent paradoxes in hybrids to make them work. By the time you've modified the deed enough to get the ability to negative gear, you lose asset protection and income splitting. But by changing the deed to get asset protection and income splitting, you lose the negative gearing aspect. I'd be quite willing to pay through the nose for a deed that proves it can sail the fine line between these issues and achieve the promised results.

 

[Shuttergirl]

Thank you all so much for your feedback on this. I am still endeavouring to understand this more but James I think you are right, it is making me feel a little uncomfortable because I just haven't come to grips with the whole thing so I think I will just get the first IP without it and keep researching and see if and when the time is right.

I was intending to get the book Trust Magic because I had seen it mentioned on several threads here that I found so it's probably a good place to start.

Thanks so much.

 

[WASP]

I recall hearing that the property investors trusts are being sold by C&N at the rate of 50 a month, maybe look at them

 

[JIT]

Dale has described the problems quiet fairly in August API the only thing missing is why, considering the requirements he set for a HDT to pass and ATO "review", would anyone bother to use a HDT.

Thanks for that, will have to get a copy of API today.

GSJ

 

[JIT]

I recall hearing that the property investors trusts are being sold by C&N at the rate of 50 a month, maybe look at them

Really, somaybe > $ 1 MM pa in sales of the PIT???

Where did you get this piece of information from WASP?

And who are they selling this thing to?!

GSJ

 

[ILoveProperty]

And who are they selling this thing to?!
GSJ

I was at a C&N/Metropole seminar very recently. Lots of eager people there. Maybe some of them believe that the PIT can do what Chan says it can.

 

[MattR]

I too am wary of HDT's with respect to property and negative gearing.

What I have seen done for those who have cash and are borrowing the balance to purchase IP's is to use a combination of DT and UT. The UT buys the property with a combination of the cash funds, which come via a DT(Settlement into) and, and borrowed funds. So the negative gearing aspect is still available for the moneys used to borrow to buy units. The units held by the DT are you're equity and are asset protected by the use of the DT (obvious exception being bankruptcy trustee powers).

Not perfect but still good.

 

[austini]

... I wrote an article about some of these issues here that I am still working on and haven't quite yet finished. ...

Hey Mry,

Thanks very much for the link. I did enjoy reading it but I have a question in regard to the section on "Redemption of the Units".

It states that if the units are redeemed at Cost then this will sink your ability to negative gear the units. I'm not so sure that one can be so black and white with such a statement in my humble layperson view.

There is no shortage of investors who have negative geared into Unit Type trusts including managed funds & commercial property trusts etc who have redeemed their units (after a year or so) at around cost or at a loss. For example, sometimes investments just don't perform as expected, they were purchased at the top of the market and then nosedived and the investor panicked, a unexpected need for the invested funds arose etc etc.

In fact I have lost count of the number of investors I have known over the years with negatived geared investments who have sold at a loss after only a year or so. As far as I'm aware the ATO never questioned their interest expense claims because they sold the units at a loss or around breakeven after only 1 - 2 years.

So if the HDT unitholder redeemed the units at around original Face value AND proof was available to show that the underlying asset was in fact genuinely this value then I would find it unfair if the ATO denied any interest expense claims up to that date. This is assuming that the HDT trust deed is well written so that the unit holder has an absolute entitlement to the income.

Athough the Tax law doesn't seem to provide any clear method for valuation I vaguely recall reading something at one stage which stated that market value is based on what an independent buyer would be prepared to pay for the property or a value determined by the owner of the property/land as long as this can be supported (perhaps a sworn valuation and/or Gov't land valuation).

Further due to these types of discussions I imagine that there are a number of HDT unit holders (who have purchased property in the last couple of years) who are feeling increasingly nervous about this arrangement . So there could be situations where, for peace of mind, the unitholder wants to redeem the units and revert back to a discretionary trust arrangement and be prepared to have future losses locked up in the DT or find other ways to inject cash flow. If these properties were purchased at the top of the property boom (eg especially in parts of Sydney) then there is a chance that the underlying asset linked to the Units may in fact be less than or close to Face Value.

Of course the above situations will no doubt be the minority but all I'm getting at is that there can be genuine situations where redemption at cost or less could happen.

Then this leads to another issue. Some redemption forms state that the units can't be redeemed at less than Cost. So if for whatever reason the unit holder needs to redeem the units (assuming the redemption value must be at least at cost) and the underlying asset is worth less than its orginal value does this mean that the unitholder has made a Capital Gain?

Cheers - Gordon

 

[alexlee]

Aren't you talking about a slightly different case, Gordon? You're actually talking about redeeming the units at MARKET, but in the limited situation where the market price is actually at or even below the cost price. I assume the redemption of units at cost will be an issue where the market price is above the cost price.

My understanding is that you would redeem units when the properties make taxable (distributable) profit. That would most likely be at least a few years after you buy the IP, at which point market price is probably above cost.

Your situation would be very limited and really only applicable where the market tanks. In which case why would a person redeem the units, and how would he/she do that anyway? The asset has fallen so the trust probably can't refinance.
Alex

 

[JIT]

So if the HDT unitholder redeemed the units at around original Face value AND proof was available to show that the underlying asset was in fact genuinely this value

But with the HDT isn't the aim to try and get redemption at market value of the special income units (SIU's), NOT, the actual underlying property. So if you don't redeem SIU's at cost, you redeem at a price just slightly higher than cost, that you work out on some rational basis - but this is much, much less than the actual market value of the property?

GSJ

 

[Mry]

Austini, I would recommend that you look at Dale's August article, particularly the first three paragraphs. Also have a look at the NTAA Voice article as well. The issue is actually as black and white as I put it. If the deed says the units must be redeemed at cost, and many do, you have a problem.

Even if you do override it to allow market, which everyone agrees is the value - what the hell is the market value? And that was the point in my article.

Love to spend more time on the article but I have about 20+ people screaming for my attention.

 

[austini]

Hi Alex,

Aren't you talking about a slightly different case, Gordon? You're actually talking about redeeming the units at MARKET, but in the limited situation where the market price is actually at or even below the cost price. I assume the redemption of units at cost will be an issue where the market price is above the cost price.

Sorry, I meant to describe a situation where the MARKET value of the Units at time of redemption is around the same as the original Face value of the Units.

My understanding is that you would redeem units when the properties make taxable (distributable) profit. That would most likely be at least a few years after you buy the IP, at which point market price is probably above cost.

This of course is what nearly all investors who negative gear intend to do. But what I was getting at is that there are plently who invest in various types of unit trust arrangements who redeem at a loss or around break even for all sorts of reasons. This is provided the Deed doesn't stipulate what you have stated must be the case.

Your situation would be very limited and really only applicable where the market tanks. In which case why would a person redeem the units, and how would he/she do that anyway? The asset has fallen so the trust probably can't refinance.
Alex

I agree it is a limited situation but I was trying to point out that this can happen. So it may not be right to state that all previous negative gearing benefits would be lost because the units were redeemed at their original face value.

In relation to refinancing etc the Unit Holder could simply agree that upon redemption of the Units instead of distributing the proceeds to the Unit holder that the funds be treated as a loan to the trust. Hence it goes back to a typical DT type of loan situation where for example a beneficiary borrows against an asset (personal or guaranteed by a third party) and loans the funds to the DT. The trust claims the interest expense, interest income is paid to the beneficiary lender which offsets their interest expense (Nil result). Of course depending on the circumstances cashflow issues may arise which need to be addressed. To be on the safe side a commercial loan agreement should be drafted at time of redemption.

Again this is unlikely but given the recent negative press about HDTs some may just be prepared to do this for peace of mind etc.

Cheers - Gordon

 

[austini]

Austini, ... Even if you do override it to allow market, which everyone agrees is the value - what the hell is the market value? And that was the point in my article. ...

Hi Mry,

Thanks for taking time from your busy schedule to answer my question.

Yes I agree with the question of what the hell is market value. Unfortunately there is now quite a few HDT investors around who will at some stage have to redeem their Units. Many of these I'm sure entered into such arrangements not thinking that they were doing anything wrong. So until the ATO issues some clear directive it seems that all one can do is take advice from his/her accountant on the matter and ensure that there is evidence or reasoning to support this.

Cheers - Gordon

 

[austini]

But with the HDT isn't the aim to try and get redemption at market value of the special income units (SIU's), NOT, the actual underlying property. So if you don't redeem SIU's at cost, you redeem at a price just slightly higher than cost, that you work out on some rational basis - but this is much, much less than the actual market value of the property?GSJ

Hi GSJ,

As has been stated it all comes back to what the heck is market value. It would be fantastic to do what you stating so long as the ATO accept your reasoning. So it seems that the skill of your accountant to argue your case and their relationship with the ATO assessors may prove invaluable.

Cheers - Gordon

 

[julia]

James

Julia, I am sure that you know the benefits of using a HDT, and Dale's article in the August issue (written some months ago now, might I add) quite clearly states that the right deeds will allow these benefits to arise. The article is simply about warning investors with poorly written deeds or receiving incorrect advice, that they do need to be careful. Dale's last paragraph of the article essentially sums it all up:
Hybrid trusts aren't dead, as some misinformed people have claimed, but the authors of trust deeds do have to be smarter...

What about a few other quotes in Dale’s article ie
“ Tax benefits are nice to have, but the stress of failing a tax review along with the pain of repaying tax benefits and fines aren’t worth the hassle, in my opinion”

And

“As a special income unit holder, you must be entitled to the income of the trust derived from the assets acquired from your subscription to the units of the trust. Without this entitlement, the nexus between the costs incurred by you in interest paid on your loan won’t be tax deductible. And the problem is that for a long time now, “income” for tax purposes includes capital gains.”

And

“…. the units are bought back at their market value for tax purposes, regardless of the price paid for those units initially. This redemption will trigger a CGT event for the individual who subscribed to those special income units.”

All Dale is saying is that some HDT deeds will pass (because they are really glorified unit trusts). I questioned what are the advantages of a HDT now?