Should I put in a Trust or not

[sandrandave]

I've built up a portfolio of 4 IPs recently and I'm a little concerned and even more confused regarding whether they are safe from litigation or not and whether they are fully protected by a trust without effecting flexability.

I have them all insured with public liability of the standard $10 000000 but have read there are circumstances where they could still be taken. I imagine this relates to being sued personally. I also understand that Trusts can be costly to set up for existing mortgages and may be harder to deal with (drawing on equity) for future acquisitions.

All help would be greatly appreciated.

Dave

 

[DaleGG]

Hi Dave

I have attached below, something that I wrote to answer just this sort of question. I hope it proves helpful.

In short though, it really depends upon what you are aiming at and whether you plan to buy a lot more property. There are many people who buy property without using a trust so please do not feel that you HAVE to do so. It is merely an option that some of us think is a good way to go for a variety of reasons.

Dale



In Whose Name Do I Buy the Next Property?
Dale J Gatherum-Goss 19 January 2006

Bare with me please and I will try to explain this succinctly and simply...

There are four possible ways to own investments:
• one name
• joint names
• company
• trust

The first two are problematic for a couple of reasons. They provide no asset protection and no flexibility. As time goes by and your circumstances change, we will rely on that flexibility to ensure that you are always in a strong position to achieve your goals.

The company is not good because there is a potential for asset sales to be taxed twice....

A trust provides
• asset protection
• tax benefits
• flexibility

It is also a structure that the wealthy people use to own assets that produce wealth. Hence, if we wish to achieve the same results that the wealthy people achieve we really should do the same things that they do...and this is to use trusts to own the assets.

When we look at trusts, there are really only three types of trust:
• a family or discretionary trust
• a unit trust
• A hybrid trust, which is a cross between the first two.

A family trust works well when we buy businesses or cashflow positive assets. It is not good when the assets are negatively geared as the losses are trapped within the trust and carried forward to absorb future profits. In this way, the individuals do not gain any tax benefits from negative gearing.

A unit trust works well when two (or more) unrelated parties buy assets together. There is no real advantage (in Victoria anyway) in using a unit trust within a single family unit as we lose the discretionary features or benefits that are available to help reduce the family tax.

A hybrid trust is best when the one family wants to buy assets that may be negatively geared as it enables the assets to be owned by the trust, but the individual to benefit from negative gearing against their other income such as salary.

Therefore, based on these simple rules...we would normally recommend a hybrid trust for property ownership when your intention is to build a decent portfolio of assets for the future.

I've built up a portfolio of 4 IPs recently and I'm a little concerned and even more confused regarding whether they are safe from litigation or not and whether they are fully protected by a trust without effecting flexability.

I have them all insured with public liability of the standard $10 000000 but have read there are circumstances where they could still be taken. I imagine this relates to being sued personally. I also understand that Trusts can be costly to set up for existing mortgages and may be harder to deal with (drawing on equity) for future acquisitions.

All help would be greatly appreciated.

Dave

 

[redwing]

I'm with Dale, there's more benefits to using a Trust Structure than merely Asset Protection-There's Retirement Planning, Tax Advantages, Succession Planning. I have several IP's outside of the Trust and 1 in the trust with plans to add another through this structure.

The Only way to Fully Protect them I'm led to believe is have them in Seperate Trusts (expensive, so some have 2-3 in each Trust)


Redwing

 

[MichaelW]

A hybrid trust is best when the one family wants to buy assets that may be negatively geared as it enables the assets to be owned by the trust, but the individual to benefit from negative gearing against their other income such as salary.

Dale,

Would you also recommend a Hybrid Trust in the situation where you're investments are generating a positive income and you're looking to minimise your tax liability?

My specific personal situation is that I currently only own managed funds generating a positive income or positive capital growth, and I want to sell these down and diversify into different funds. I wanted to use this opportunity to setup an appropriate structure to hold these assets so I can minimise my tax bill. I'm not so concerned about asset protection, but as a Director of a company this does factor somewhat. I don't need the extra income so could happily "hold it back" for tax effectiveness.

So, before I diversify this week or next, I was going to go onto LawCentral and buy an HDT to buy the new Managed Fund units in.

Is this a smart thing to do?

Thanks,
Michael.

 

[Patosan]

G'day Dave,

Well you have some good advice on Trust structure benefits now.
Assumng that you like the idea of Trusts you then have to decide if it's worth the rather large cost of moving your existing 4 IP into a trust.

It's a big question since not only are you thinking of the long term ramifications ... you can't escape the cost pain upfront. There are several costs the biggest 2 generally being state duty and CGT, the latter could be truly huge depending on your specific cases. We DID put 2 IP into trust a few years ago now, though only had one a short time and the other had been my PPOR so there was little to no CGT. However the duty alone was daunting ... in the 50k ballpark ... that's today's dollars and puts a big dent in funds.

So I'd suggest decide :
1. Do you like trusts ?
2. If yes ... what would your CGT hit be ?
3. Then what would your state duty be ?
4. Add duty & CGT then allow for trust set up costs.
5. Finally weigh up if you want to do.

Good luck mate

 

[DaleGG]

Hiya Michael

As the cashflow from your investments in managed funds will be positive then a simple discretionary trust should be sufficient to use.

I am a big believer in keeping things as simple as I can. It's the only way that I can cope....


Dale

Dale,

Would you also recommend a Hybrid Trust in the situation where you're investments are generating a positive income and you're looking to minimise your tax liability?

My specific personal situation is that I currently only own managed funds generating a positive income or positive capital growth, and I want to sell these down and diversify into different funds. I wanted to use this opportunity to setup an appropriate structure to hold these assets so I can minimise my tax bill. I'm not so concerned about asset protection, but as a Director of a company this does factor somewhat. I don't need the extra income so could happily "hold it back" for tax effectiveness.

So, before I diversify this week or next, I was going to go onto LawCentral and buy an HDT to buy the new Managed Fund units in.

Is this a smart thing to do?

Thanks,
Michael.

 

[sandrandave]

Thanks to all for your input it's greatly appreciated.

I had heard/read that it can often be a painful experience adding current properties into a trust. For this reason, I'm probably best talking to my solicitor and looking at adding future properties into trust arrangements. The Hybrid seems to be the one to look into as negative gearing is something I work with.

Thanks again,
and let's keep the knowledge sharing going,


Dave

 

[geoffw]

I had heard/read that it can often be a painful experience adding current properties into a trust.

Yep. EXpensive.

You'll have to pay stamp duty; if it wasn'y a PPOR, CGT may also have to be paid.

 

[MichaelW]

Hiya Michael

As the cashflow from your investments in managed funds will be positive then a simple discretionary trust should be sufficient to use.

I am a big believer in keeping things as simple as I can. It's the only way that I can cope....


Dale

Thanks Dale,

And if I'm also planning on buying some negatively geared IPs in the near future, would this mean I should just bight the bullet and go HDT now for both the managed funds and IPs? I figure I can do the lot under the one structure and not get too messy with a DT for the funds and an HDT for the IPs.

OK?

Cheers,
Michael.

 

[DaleGG]

Hiya Michael

Absolutely right. The one trust can be used for both activities and this provides flexibility and leaves options open down the track if oy decide you need them.

Dale

Thanks Dale,

And if I'm also planning on buying some negatively geared IPs in the near future, would this mean I should just bight the bullet and go HDT now for both the managed funds and IPs? I figure I can do the lot under the one structure and not get too messy with a DT for the funds and an HDT for the IPs.

OK?

Cheers,
Michael.

 

[emw]

Thanks for bringing this topic up, just what I want to learn about at the moment before buy my 1st IP

 

[Bandita]

Thanks for such great input, my fiance and I have been debating on using a trust as well. We bought our first IP in joint names, mainly for immigration reasons (loan in both names, joint bank accounts associated with the loan - makes everything so much easier!), but we're about to purchase our second IP and are weighing the pros and cons.

The IP would most likely be negatively geared for the near future at least. My fiance currently makes much more money than myself, so we were going to put it in his name, but it appears a hybrid trust seems to allow for negative gearing? As I have just started working full time and will be earning much more than present day in the near future - is a hybrid trust flexible with these types of changing circumstances? My fiance is a pharmacist - I'm not sure exactly how the laws work, but I'm worried that if something were to go wrong in the future (it's not him I'm worried about, he's a fantastic pharmacist - but what if someone gives him a script for the wrong medication or fails to tell him their allergies to a drug, etc?) our assets could be in jeopardy - would a hybrid trust be the best way to protect our assets from that type of litigation?

Also, what are the costs involved in setting up a hybrid trust?

We mentioned to our accountant about buying an IP in a trust and he said it wouldn't be very benefial as you can't negative gear - I'm beginning to think it's time to move on! Any recommendations for accountants in Melbourne who have experience with trusts for property investors?

Cheers,
Jen

 

[geoffw]

My fiance currently makes much more money than myself, so we were going to put it in his name, but it appears a hybrid trust seems to allow for negative gearing?

That's my understanding[/quote]

As I have just started working full time and will be earning much more than present day in the near future - is a hybrid trust flexible with these types of changing circumstances?

Also that's my understanding.

My fiance is a pharmacist - I'm not sure exactly how the laws work, but I'm worried that if something were to go wrong in the future (it's not him I'm worried about, he's a fantastic pharmacist - but what if someone gives him a script for the wrong medication or fails to tell him their allergies to a drug, etc?) our assets could be in jeopardy - would a hybrid trust be the best way to protect our assets from that type of litigation?

Do a search in the forum. And look at Dale's "Trust Magic" book.

We mentioned to our accountant about buying an IP in a trust and he said it wouldn't be very benefial as you can't negative gear - I'm beginning to think it's time to move on! Any recommendations for accountants in Melbourne who have experience with trusts for property investors?

What else could I say but forumite and very valued contributor Dale

 

[Bandita]

Thanks GeoffW!

Do you know what the associated costs are with setting up a hybrid trust?

Cheers,
Jen

 

[ggumpshots]

The finer details of HDT and units

I understand the broad picture of Hybrid discretioary trusts but not the finer details.
With a Hybrid Discretioary trust , HDT,set up for use by a a family for example, the Higher bread winner owns the units.
eg man works in the coal mine... wife cuts wheat and makes bread at home.

Next asume roles become reversed.At this point does the man sell/ give back ,the units to the trust and the wife now buys/ is given, the units of the HDT.

She can now use the interest deducuctions against the trust income she is entitled to.

Are there any costs with units exchanging hands. CGT/ stamp duty/solicitors fees etc... This is the part I am unclear on.
Have I got it right???????????????????

 

[kierank]

Are there any costs with units exchanging hands. CGT/ stamp duty/solicitors fees etc...

My understaning is that there is no CGT (as one sell the units for the same price they were purchased for), no S/D and no need for solicitors but you have to maintain the paperwork/audit trail (i.e. unit certificates, unit registers, etc).

I have a HDT and have purchased units but haven't sold any as yet. Probably will do so in the future when I want the HDT to take on some of my loans.

PS I am not a solictor, just a novice investor - so the above is my understanding/opinion.

 

[geoffw]

Thanks GeoffW!

Do you know what the associated costs are with setting up a hybrid trust?

I don't know- your local friendly accountant could tell you. (I don't have an HDT, my last property purchase was a few years ago before I knew about them- and this property is OK in a family trust).

There are ongoing fees as well as establishment fees.

 

[PurpleP]

I’m reading a book by a well known author and investor who argues that trusts are not necessary.

Below is an outline of the authors arguments. I would appreciate Dale or Nick or whoever else commenting on these.

DTs
1…. I am often told by readers that they are worried that their tenants may sue them, but I remind them that public liability is included in all land lords insurance. This is usually around $10mill of cover & there is a cap on claims for anyone injuring themselves well below this.. So unless you are in the medical profession or involved in unscrupulous business dealings it is unlikely you would need that level of cover.
2. If you are sued and your assets are in a trust, this does not necessarily mean they are protected. Both ASIC & the Family law court have the power to unwind a trust to reach the assets in the invent that creditors, litigants or spouses need to be paid.
3. A trust pays no tax. Positive cash flow from a property is a result of making tax claims, the benefits of which make up the margin in your cash flow and give you extra money each week. The higher the tax bracket you are in the more tax you get back from your claims and the higher likelihood of seeing a positive cash flow from your investments. Property in a trust means that the entity that owns the asset ( the trust) cannot enjoy the tax benefits (as it pays no tax) and the entity that receives the income ( the beneficiaries) has no access to tax benefits to offset the extra income received. …. In later years as debt reduces and income increases, the increased income must be distributed and will be tacked on top of other income earned pushing the recipient into the higher tax bracket.
4. While it is true when you retire you may be in a lower tax bracket and the trust can distribute as it sees fit to those who pay the lowest tax, the facts are that most trusts are only set up with one or two beneficiaries-usually spouses or partners. By the time they retire they may have many properties earning a lot of income & having the income flow through a trust will do little if anything to change the amount of tax you ultimately pay when it ends up in your hands. If your children are also beneficiaries, this means you can also give them an income ( why would you do that as you have retired and need it?) or you can distribute it to them and they give it back to you and as by this stage they are probably already earning other income so their income tax may be levied at a higher rate.
If the unlikely event they are still under 18 when you retire they have a very small tax free threshold.

In conclusion the author goes on to write the following.
.. The realities are that if you build a substantial property portfolio, you are going to pay a lot of tax regardless of whether you receive the income in the hand or through a trust. I cannot see any real benefit in buying property in a trust. It fails as an asset protection tool, it fails as a tax shelter, & as I said before it does remove those tax benefits that are so important in the early years in helping you build a bigger portfolio ( as they give you important cash flow today when you need it most.

HDTs
Without boring you all with about three paragraphs of intro, the author outlines what a HDT is and then goes onto the following
…..so far I have not found anything in any legislation to support the HDT theory. Lets assume for a minute that there is a loophole that can be accessed by setting up this complex srtucture- always remember that if you take advantage of these unteseted arrangements, you may be exposing yourself to harsh penalties under the general anti avoidance provisions of tax legislation(PartIVA)

Companies ( buying property through them)
….If you wish to buy positive cash flow property, often the cash flow is negative until you receive the tax breaks. By using a company structure, you are intentionally setting your max tax breaks at 30%. when it may be possible as an individual you may be in a higher bracket than that……if the income received has already paid 30% company tax & you withdraw funds from the company you must still pay the difference when the money hits your hand….So as the properties go onto make real money ( by reducing debt and increased rents) you will want to have the cash and you have no choice but to draw it down and pay whatever tax is due on it.
Lastly companies lose the concession on CGT and of course there are additional compliant costs with running a company

A lot of the above is not word for word as this post is already a long one and I tried to summarize where possible without changing the vibe

Cheers
PP

 

[MichaelW]

HDTs
Without boring you all with about three paragraphs of intro, the author outlines what a HDT is and then goes onto the following
…..so far I have not found anything in any legislation to support the HDT theory. Lets assume for a minute that there is a loophole that can be accessed by setting up this complex srtucture- always remember that if you take advantage of these unteseted arrangements, you may be exposing yourself to harsh penalties under the general anti avoidance provisions of tax legislation(PartIVA)

PP,

So basically the author is arguing that HDTs are illegal. I'm sure NickM and DaleGG would argue that point. Assuming they're legal, then they definately work as a way of minimising your tax if you hold several negatively geared properties. I don't think he's challenging this, just the legality of the structure.

Cheers mate,
Michael.

 

[PurpleP]

Hi Michael
The author didn't say they were illegal. I guess just intimating that they may be open to challenge by the ATO in the future and possibly be reigned in or legislated against. ( as most politicians probably have at least one of these structures I somehow doubt it)
The author does beleive strongly in positive cash flow property and this may be the cause of their particular view. I must say it has made me think before leaping into trusts. Not from a .....are they legal point of view? but are they necessary?

PP