Hybrid Discretionary Trusts - New Rules and Benefits?

I've been scouring this forum to try and understand the new rules and benefits of using a HDT, to try and pull everything together in one place in a layman's summary for people like me who only just grasp the concepts

Please treat this post as a question - are these points below correct?

I really appreciated the hours that have gone in to writing this thread. I originally posted at the end of this thread, but its lost on page 13.

I’m Mum and Dad investor, both salary earners, building negatively geared property in a HDT structure (reasonably typical?) looking for ways to tax plan effectively and divert more income to mum, or more deductions to Dad, now that mum is only working part time.

So here's the rules/benefits as I understand them...

1. We borrowed money to buy Special Income Units in the trust/HDT 50% mum, 50% dad. Lets say it was $50k each to buy a $100k investment property. As long as I a) get my trust amended, and b) continue to distribute income 50/50 to mum and dad, then the interest is still deductible in our individual names.

2. Regardless of the fact that the property is now worth $220k, income must be split in proportion to the unit holdings. Ie 50/50. We can no longer, stream any income to Mum.

3. If we sell the property then trust makes $120k capital gain. This can be streamed to Mum, providing the right paperwork is in place – ie. resolution/minutes and trust amendments (although I have a 2005 MSG HDT so I don’t need the trust deed amended).

4. If instead of selling the property, the trust borrows money (I know technically the trustee borrows money on behalf of the trust, but if don’t keep it simple, I’ll lose my thoughts..) to redeem the units…

5. The units must be redeemed at market value (ie. Property is worth $220k so the units we purchased at $100k are now worth $220k, (although it might be possible to calculate the reasonable market value of the units at something bit less than $220k)

6. The interest on the loan the trust has taken out to redeem the units, remains deductible in the trust; regardless of what Mum and Dad do with the money – eg pay off the initial $100k loan and go on a holiday with whatever money is left after…

7. Capital gains tax is payable on the $120k gain, in the hands of Mum and Dad. Is this taxable as a capital gain, or a revenue/dividend after capital is return (ie. do we get the 50% capital gains reduction or not?)

8. Borrowing money in the trust to redeem units, effectively moves the loan out of mum and dads names and puts more deductions in the trust, reducing the income that is distributed.

9. Now that all the units in the trust have been redeemed, the trust converts to a Discretionary Trust and can allocate income however in determines.

10. We could do a “half step” toward this and only redeem mum’s units, with the result that mum no longer owns units and all the income is distributed to Dad (now the only unit holder). With the proceeds of the redemption, we pay out the loan in Mum’s name.

11. If, however, the property is still negatively geared, then now the trust is making a loss. This loss cannot be distributed to beneficiaries (we lose the benefit of the tax deductions until such time as the property becomes positively geared and the trust can deduct prior year losses, before distributing the income), so I’d need to be mindful of this when the trust borrows money to redeem units.

12. One question on market value – If in the above example, Mum and Dad did nothing now but bought a 2nd property. So $50k each in units 4 years ago, property 1 worth $220k, mum and dad buy another $50k each of units (with borrowed money in their own name) and the trust buys another property for $100k in the HDT structure. One year later the property is worth $110k.

13. Is the 2nd lot of units we bought a year ago worth a lot less than the first lot of units we bought 4 years ago? If we want to minimise capital gains, can we just redeem the units that we purchased most recently?

14. If point 13 is correct, I guess we lose the benefit of ever being able to turn equity in to cash (refinancing principle) for those particular units (as opposed to waiting 5 years until the 2nd lot of units were also increased in value from continued growth in both the first and second properties)

I’m hoping this will benefit a lot of people like me, who are not tax professionals, but really want to understand some of the typical scenarios and concepts.

Anyone care to go through and give me a tick or a cross on each of the 14 points?
 
Hi
I don’t think there are any new ‘rules’ just clarification from the ATO on what they won’t allow in terms of deductibility of interest – especially uncommercial transactions
1. Trust need may need to be amended if it is not complying. Before doing so much sure that this won’t result in CGT and Stamp duty on the whole of the trust assets – ie no resettlement. If the trustee is required to distribute all income to the unit holders in proportion to the holdings and the unit holders borrowed to buy these units then the unit holders could probably claim the interest for these loans.
2. If the unit holders want to keep claiming 100% of the income then the trustee cannot have any ability to stream income to others.
3. CGT would need to go to the unit holders in proportion to their holdings if the deed specifies this – which it probably would had the unit holders been claiming the interest.
4. Yes.
5. Yes
6. Yes, if the trustee borrows money to buy the units it would possibly be deductible. This is known as ‘the refinancing principle’.
7. If mum and dad were persons then they would qualify for the 50% CGT Dsicount and the income would retains its character as a capital gain. (not so if the unit holders were a company)
8. Yes.
9. Yes. Incidently you could redeem units over a number of years to reduce your CGT.
10. Yes
11. Yes. But probably whenever you transfer the units the trust would be negative geared because the trustee would be paying market value for the units and borrowing the full amount.
12. Buying 2 properties in the one trust would complicate things. The trust could possibly issue different classes of units...
13. ??
14. ?? Probably best to use a new trust for the next purchase I think.

Seek medical and legal advice before attempting this at home!
 
Terry thanks for the reply - it helps a lot!

3. CGT would need to go to the unit holders in proportion to their holdings if the deed specifies this – which it probably would had the unit holders been claiming the interest.


11. Yes. But probably whenever you transfer the units the trust would be negative geared because the trustee would be paying market value for the units and borrowing the full amount.

12. Buying 2 properties in the one trust would complicate things. The trust could possibly issue different classes of units...

Re #3 - so I guess the discussion here about TLAB 5. is more applicable to discretionary trusts? (or HDT's after all units have been redeemed and they revert to discretionary).

Re #11. Thats a very good point, so I suppose the smart thing to do is only borrow to redeem a number of units the point that the trust is still making a small amount after borrowing costs, otherwise the loss is trapped inside the trust?

re #12. Oh dear - I have 4 properties in this trust... time to find a good adviser. Recommendations?

Generally, it seems the number of benefits of having property in a trust structure have some-what diminished for people in my situation, unless you need it for asset protection, have other income coming in to the trust (to maximise the "refinance principle"-ability for example), or want to invest your super in to property via an SMSF.
 
Generally, it seems the number of benefits of having property in a trust structure have some-what diminished for people in my situation, unless you need it for asset protection, have other income coming in to the trust (to maximise the "refinance principle"-ability for example), or want to invest your super in to property via an SMSF.

HDTs didnt ever really have the same level if AP as DTs with a corp trustee.

I still believe though that trusts have a great benefit beyond the hassles they can come with.

Like many things in life, we have trouble seeing the end picture while in the pain of the moment

ta

rolf
 
HDTs didnt ever really have the same level if AP as DTs with a corp trustee.

I still believe though that trusts have a great benefit beyond the hassles they can come with.

And I would argue the benefit of that is in direct proportion to the size of your portfolio.
 
Asset Protection aside for a minute, for mum and dad investors it seems the main investment benefits left are:

1. The 'refinance principle' albeit limited because if you borrow too much and redeem too many units, your trust could be losing money (and therefore you lose the tax benefit as trusts can't distribute losses?).

2. Flexibility to use your SMSF to invest in some of the units.

3. Any other main benefits?
 
There is absolutely no asset protection in Hybrid trusts (or the tax compliant ones anyway) as the units are property.

The main benefit is that the units can be transferred without the need to transfer title of the asset. This gives maximum flexibility.

The refinancing principle is the other.
 
I don't think in Vic we have the same benefit for hybrid trusts (with respect to transfer of units) because of the 'land rich' provisions in the Duties Act.
 
I don't think in Vic we have the same benefit for hybrid trusts (with respect to transfer of units) because of the 'land rich' provisions in the Duties Act.

Hi Aaron,

Most states have Land Rich provisions. NSW and QLD do as well as VIC. What this means is that more stamp duty may be payable if the entity owns land valued over a certain value - often $1mil.

But this doesn't detract from the benefits I outlined above because units in a unit trust or a HDT could still be transferred without the need to change the ownership of the property. Stamp duty may be payable on the transfer of units but it would have been payable on the transfer of ownership of the property anyway - and it may even work out cheaper to transfer the units rather than the property.

It is just a must simpler exercise in transferring units. I think, and going from memory here, that the SIS Act may allow the transfer of units in residential property from a related trust but not the propert itself. (maybe wrong).
 
Macquarie have a fact sheet called "Operating your trust post amendment" which would answer a lot of your questions. It goes through the order of redemption and sale to ensure double taxation doesn't apply when you sell, and runs through a practical example. See if you can get a copy.

I would love to answer your questions in more detail, but there's too many questions for me.
 
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