IP & Tax Minimisation

[x452]

Before I speak to a solicitor I'd like to learn as much as possible.

My parents would like to transfer their IP over to us. I earn around double what my wife earns. Would it make sense to have the property in my name or my wife's? If in my name I can claim all the tax deductions against my higher income. If in her name she would pay less income tax on any rental income (if positively geared) and less CGT.

Also would it make sense to setup a Family Trust in this situation? Then how would any tax deductions work, who gets them? Could I then distribute any income or capital gains to my wife or 2 year old son?

 

[alexlee]

Before I speak to a solicitor I'd like to learn as much as possible.

My parents would like to transfer their IP over to us. I earn around double what my wife earns. Would it make sense to have the property in my name or my wife's? If in my name I can claim all the tax deductions against my higher income. If in her name she would pay less income tax on any rental income (if positively geared) and less CGT.

Also would it make sense to setup a Family Trust in this situation? Then how would any tax deductions work, who gets them? Could I then distribute any income or capital gains to my wife or 2 year old son?

A lot of questions. Breaking it down:
1) You earn double what your wife earns: how much is that? It depends on your marginal tax rates. Say your wife makes 35k and you make 70k. There's no much difference because you're both in the same marginal tax bracket. If it's 100k and 200k, that's different.

2) You can't deduct expenses against one person and claim gains for the other even if it's in joint names. Net taxable income/loss gets split according to the ownership %. What's the taxable gain/loss on this thing?

3) Which brings me to the next question: will you have a loan against this IP?

4) also, are your parents aware that they will have to pay CGT on the sale? And that you have to pay stamp duty?

5) what transfer price are you planning to use? You must use a reasonable one. e.g. get a valuation done by a qualified valuer to back up your parents' CGT claim on their tax return.

Using a FT may make sense, but remember if the IP is making a tax loss tax losses can't be distributed and will be carried forward. You need to figure out whether you've going to make a taxable loss or gain on this first. Your 2 year old has a very low tax free threshold but can take a few hundred dollars in income. Capital gains only apply when you sell, but yes, if you put it in a FT you can distribute CG to different beneficiaries.
Alex

 

[x452]

1) Say she earns 30K (she'll be working part-time for another year) and I earn 90K.

2) It's worth about $100K more now.

3) No, it's already paid off.

4) My parents lived in it for more than a year so they don't have to pay CGT. Yes I am aware I will have to pay stamp duty.

5) The council valued the property at $268,000 last year.

Seems like a FT is the best option for us. We don't want to transfer it solely into my wife's name because that leaves me out of it. So the idea is to setup a FT with me as the Trustee and have my wife and my son as beneficiaries. We then transfer the house into the FT and allocate any income (and CGT eventually) to my wife because she's in a much lower income bracket to myself.

 

[alexlee]

Hold on.

$100k more than what? Purchase price?

Your parents lived in it for a year, so what are they living in now? Are they still living in it, in which case their PPOR exemption applies, but what are they living in after this? Are they going to pay market rent? Renting your own home from a trust is usually frowned upon by the ATO, though in your case if it's fully paid off......

Is the council valuation just land or does it include the building?

If it's already paid off, and your parents are just giving it to you for free..... aren't there laws against this sort of thing with tax implications?

Actually, if you're going to use an FT, the easiest way may be for your parents to 'gift' it to the FT, set up a corporate trustee with you and your wife as directors. A family trust would include both of you and your child as beneficiaries.

Do you already have plans to sell the property?
Alex

1) Say she earns 30K (she'll be working part-time for another year) and I earn 90K.

2) It's worth about $100K more now.

3) No, it's already paid off.

4) My parents lived in it for more than a year so they don't have to pay CGT. Yes I am aware I will have to pay stamp duty.

5) The council valued the property at $268,000 last year.

Seems like a FT is the best option for us. We don't want to transfer it solely into my wife's name because that leaves me out of it. So the idea is to setup a FT with me as the Trustee and have my wife and my son as beneficiaries. We then transfer the house into the FT and allocate any income (and CGT eventually) to my wife because she's in a much lower income bracket to myself.

 

[x452]

$100k more than what? Purchase price?

Yes. They bought the land for $50K and built the house for $120K so the total cost was $170K, now it's worth $270K.

Your parents lived in it for a year, so what are they living in now? Are they still living in it, in which case their PPOR exemption applies, but what are they living in after this? Are they going to pay market rent? Renting your own home from a trust is usually frowned upon by the ATO, though in your case if it's fully paid off......?

They're living in another PPOR now and renting this place out. I thought the PPOR exemption was you must have lived in it for more than 1 year - do you still need to be living in it to avoid CGT?

Is the council valuation just land or does it include the building?

Land and building.

If it's already paid off, and your parents are just giving it to you for free..... aren't there laws against this sort of thing with tax implications?

This is what we need to find out. Whether we actually have to pay them for it to make it legit?

Actually, if you're going to use an FT, the easiest way may be for your parents to 'gift' it to the FT, set up a corporate trustee with you and your wife as directors. A family trust would include both of you and your child as beneficiaries.

I'm confused. Is a corporate trustee different to a FT?

Do you already have plans to sell the property?

Not at this stage. Ideally would like to hold on to it for quite some time.

 

[alexlee]

Yes. They bought the land for $50K and built the house for $120K so the total cost was $170K, now it's worth $270K.

They're living in another PPOR now and renting this place out. I thought the PPOR exemption was you must have lived in it for more than 1 year - do you still need to be living in it to avoid CGT?

Short answer, yes. You need to have been living in that property for the whole period to claim the entire CGT exemption. Think of what you're saying: if it worked like you said I would move homes every year and eventually have dozens of CGT-free IPs.

If your parents now claim another PPOR, they can only claim PARTIAL CGT exemption, basically from when they built it / moved in to when they moved out. If they didn't have a valuation done when they moved out, you'll need to do estimates.

This is what we need to find out. Whether we actually have to pay them for it to make it legit?

Check with your accountant / solicitor on laws on gifts.

I'm confused. Is a corporate trustee different to a FT?

A Family Trust must have a trustee. That can be you, another person or more commonly a company. Using a company trustee makes things easier when it comes to transferring assets (e.g. say your child is 30 and you just want to give control of the trust assets to him. With a company trustee you just transfer the shares in the trustee company to him without having to incur stamp duty.

I'm wondering whether you have an issue with gifts. You might be able to get around it by having your parents gift the IP to the family trust. They'll still have to pay CGT.
Alex

 

[x452]

If your parents now claim another PPOR, they can only claim PARTIAL CGT exemption, basically from when they built it / moved in to when they moved out. If they didn't have a valuation done when they moved out, you'll need to do estimates.

I think I get it now. So they can claim partial CGT exemption on the 1st property (the one they want to give to us) based on when they moved into it to when they moved out. They can claim the full CGT exemption on the current house they're living in which they also built and moved into, and have been there ever since.

Any restrictions on how many properties you can claim CGT exemption on?

So with 'gifting' the property to the FT, they'd still pay CGT and I'd still pay stamp duty. So no real gains in the transfer process but will allow us to allocate income and any CGT to my wife (lower tax rate) or any other adult beneficiary.

With an FT, how would the deductions work if we still had a mortgage on the property? Say there was $10K in deductions is it possible for me to claim those and my wife to claim the CGT when we sell (in 1, 5 or 10 years)?

 

[Mr. Fabulous]

Short answer, yes. You need to have been living in that property for the whole period to claim the entire CGT exemption. Think of what you're saying: if it worked like you said I would move homes every year and eventually have dozens of CGT-free IPs.

That's not correct. They can claim CGT exemption for up to six years after they have moved out. But they will lose the CGT exemption for the period they were living in another PPOR.

Let's say your oldies bought PPOR 1 in 2001. They then move out in 2004 into PPOR 2. They sell PPOR 1 in 2008 and claim CGT exemption for the years 2004 - 2008 on PPOR 1. They then lose the CGT exemption on PPOR 2 for the years 2004 - 2008, hence they will pay CGT on PPOR 2 (after the 50% discount) for those years if they sell.

At least that's how I understand it, from the way it was explained to me.

Mark

 

[x452]

Let's say your oldies bought PPOR 1 in 2001. They then move out in 2004 into PPOR 2. They sell PPOR 1 in 2008 and claim CGT exemption for the years 2004 - 2008 on PPOR 1. They then lose the CGT exemption on PPOR 2 for the years 2004 - 2008, hence they will pay CGT on PPOR 2 (after the 50% discount) for those years if they sell.

Would it be possible to forego claiming the CGT exemption on PPOR 1 for the period 2004-2008 and keep it for PPOR 2 because PPOR 2 will be worth a lot more on sale?

So they can claim partial CGT exemption on PPOR 1 for 2001-2004 and claim it entirely on PPOR 2 when they sell.

 

[alexlee]

That's not correct. They can claim CGT exemption for up to six years after they have moved out. But they will lose the CGT exemption for the period they were living in another PPOR.

The 6 year rule only applies if they do not claim another PPOR after moving out of the first one. You can't have two PPORs.
Alex

 

[geoffw]

Would it be possible to forego claiming the CGT exemption on PPOR 1 for the period 2004-2008 and keep it for PPOR 2 because PPOR 2 will be worth a lot more on sale?

So they can claim partial CGT exemption on PPOR 1 for 2001-2004 and claim it entirely on PPOR 2 when they sell.

My understanding is yes- if there are two houses for which CGT exemption will apply, they can choose which property they wish to claim as exempt for the overlapping period.

I may be wrong on that- a qualified accountant may have a more accurate answer.

 

[alexlee]

Any restrictions on how many properties you can claim CGT exemption on?

One at a time, though there is an overlap when you move out of one and are buying another.

So with 'gifting' the property to the FT, they'd still pay CGT and I'd still pay stamp duty. So no real gains in the transfer process but will allow us to allocate income and any CGT to my wife (lower tax rate) or any other adult beneficiary.

Yes, they still pay CGT and the trust pays stamp. You can distribute to minors too, but not much because they have very low tax free thresholds.

With an FT, how would the deductions work if we still had a mortgage on the property? Say there was $10K in deductions is it possible for me to claim those and my wife to claim the CGT when we sell (in 1, 5 or 10 years)?

With a FT, you can't distribute losses. Loans will have to transferred into the name of the trust as well. Losses have to be offset by income made by the trust (rent, etc). When the trust sells, it makes CG which is distributed to beneficiaries.
Alex

 

[x452]

With a FT, you can't distribute losses. Loans will have to transferred into the name of the trust as well. Losses have to be offset by income made by the trust (rent, etc). When the trust sells, it makes CG which is distributed to beneficiaries.
Alex

So with an FT I lose the opportunity to offset my high income tax with deductions from the property. To do that I would need to have the property in both my mine and my wife's name, so we split 50/50 the deductions as well as the gains. There's no way to have the property in both names and I take 100% of the deductions and she takes 100% of the gains is there?

 

[alexlee]

So with an FT I lose the opportunity to offset my high income tax with deductions from the property. To do that I would need to have the property in both my mine and my wife's name, so we split 50/50 the deductions as well as the gains. There's no way to have the property in both names and I take 100% of the deductions and she takes 100% of the gains is there?

You wish.

In any case, you have to be very careful here. If you have no loans against the property, it's likely to be tax positive. If you borrow against the property to get interest deductions, you have to be careful what you do with the proceeds of the loan. Use it for private purposes and you don't get the deduction.

I really think you want to think about this further before doing anything. At the very least talk to your lawyer / accountant about how you can deduct (or claim income) in the various names.
Alex

 

[alexlee]

So with an FT I lose the opportunity to offset my high income tax with deductions from the property.

Yes, but you also gain the advantage of distributing taxable gains to the beneficiary with the lowest taxable income. Given that IP doesn't have loans against it, it'll probably have taxable income from year 1.
Alex

 

[Mr. Fabulous]

The 6 year rule only applies if they do not claim another PPOR after moving out of the first one. You can't have two PPORs.
Alex

That's what I said!

Mark

 

[x452]

Yes, but you also gain the advantage of distributing taxable gains to the beneficiary with the lowest taxable income. Given that IP doesn't have loans against it, it'll probably have taxable income from year 1.
Alex

DISCLAIMER: Amateur at work!

Consider these 4 options if over 10 years the value of a negatively geared IP doubles from $150K to $300K:

Tax Payer 1: Salary = $90,000, Tax @ 27% = $24,300 p.a.
Tax Payer 2: Salary = $70,000, Tax @ 24% = $16,800 p.a.

Tax deduction from IP: $10,000 p.a.

Option 1 - Place IP in the name of a FT

Pros: Taxable gains can be distributed to my wife as the lower income earner. Capital gains would be paid at the lower marginal tax rate of 30%. Which would equate to $22,500 after 10 years.
Cons: Taxable losses cannot be distributed to any of the beneficiaries, can only be offset against the Trust's income.

Net capital gain = $127,500

Option 2 - Place IP in my name

Pros: Taxable losses can be used to lower my taxable income. Deducting the tax deduction from the IP of $10,000 from my taxable income of $90K brings a tax saving of $2,700 a year, or $27,000 over 10 years.
Cons: Capital gains would be paid at the higher marginal tax rate of 40%. Which would equate to $30,000 after 10 years.

Tax saving = $27,000
+ Net capital gain = $120,000
Net Profit = $147,000

Option 3 - Place IP in wife's name

Pros: - Taxable losses can be used to lower her taxable income. Deducting the tax deduction from the IP of $10,000 from her taxable income of $70K brings a tax saving of $2,400 a year, or $24,000 over 10 years.
- Capital gains would be paid at the lower marginal tax rate of 30%. Which would equate to $22,500 after 10 years.
Cons: Taxable loss would be used to lower her taxable income which is lower than mine, although the difference over 10 years is only $3,000.

Tax saving = $24,000
+ Net Capital Gain = $127,500
Net Profit = $151,500

Option 4 - Place IP in joint names (50/50)

Pro/Con: Taxable income and losses will be split 50/50 between the two of us.

Tax saving for myself after 10 years: $13,500
Tax saving for wife after 10 years: $12,000
Total tax saving after 10 years: $25,500

Total CGT for myself after 10 years: $15,000
Total CGT for wife after 10 years: $11,250
Total CGT after 10 years: $26,250

Tax saving = $25,500
+ Net capital gain = $123,750
Net Profit = $149,250


So option 3 would yield the highest net profit.

 

[alexlee]

Pretty much, though remember you get the CG discount if you hold the thing for more than 12 months.

You can't estimate the numbers to any degree of accuracy, since you dont' know what the tax rates and your incomes will be in 10 years. However, the basic theory holds: the biggest chunk of gain will be from the CG. You're ignoring a lot of things, though. Such as:

1) Are you actually borrowing money against this property? The only way you could make it deductible is borrow money to buy it off your parents and actually give them the money. Since your parents are going to give you the IP, what's their take on this?

2) If there is no gearing against it, then it's guaranteed to be tax positive from day 1. That really changes your figures.

3) Even if it starts off as negative, it's likely to become positive in a few years. That's why buying it in the highest income earner's name isn't always the best solution in the long run.

4) What if you hold the property for 16 years or more? Then your kid hits 18 and gets the full adult tax threshold. THAT's when putting it in a trust really pays off, because you can split CG between, say, your wife and your child.

What I don't see in all of this is a long term plan. Are you happy just to take this IP, hold it for 10 years, and then sell? What are you going to do with the money? Would you consider, for example, refinancing the IP to buy more property or shares or funds?

What entity/name you use really depends on what your long term plans are. e.g. do you plan to sell it after 10 years? How about after >16 years when your kid becomes 18? Do you plan to use this IP to be the core of a property portfolio?

What I'm seeing is: your parents are basically giving you a skipload of money. What are you planning to do with it?
Alex

 

[x452]

1) Are you actually borrowing money against this property? The only way you could make it deductible is borrow money to buy it off your parents and actually give them the money. Since your parents are going to give you the IP, what's their take on this?

2) If there is no gearing against it, then it's guaranteed to be tax positive from day 1. That really changes your figures.

Yes in the situation of the paid-off property it would be tax positive. It would probably still be better off in my wife's name though since she's on the lower income thus pays less tax.

3) Even if it starts off as negative, it's likely to become positive in a few years. That's why buying it in the highest income earner's name isn't always the best solution in the long run.

Fair point.

4) What if you hold the property for 16 years or more? Then your kid hits 18 and gets the full adult tax threshold. THAT's when putting it in a trust really pays off, because you can split CG between, say, your wife and your child.

Good point. It's hard to tell how long we'd hold it for. The longer the better but if we put our son through private education we may/would need to sell it.

What I don't see in all of this is a long term plan. Are you happy just to take this IP, hold it for 10 years, and then sell? What are you going to do with the money? Would you consider, for example, refinancing the IP to buy more property or shares or funds?

Most likely re-invest in one of the above if we're not in need of the funds.

Thanks very much for your responses, you have been extremely helpful!!

 

[tubs]

I think you're getting a few concepts a bit incorrect.

1. There are no tax benefits with your plan. The house is paid off, and it would be gifted to you. There is no tax deduction here, in fact, it would hurt you tax wise because your income from rent would FAR exceed the expenses, which would not include interest since there is none.

2. Your parents would have to sell you the house, probably couldnt gift it to you. This would trigger CGT for them if its an IP, and stamp duty for you. You'd have to get a loan to do so, so you'd be effectively buying an IP, and they'd be selling one.

3. If you did this in a FT, you wouldnt be able to claim any losses against your tax because losses are rolled forward year to year, and can only be claimed against future gains.

I'm sorry, but I dont see how what you're trying to do will work tax wise.