trusts again

[CHAOS]

We are looking into setting up a DFT for next IP purchase. I have having trouble getting my head around it.

How does a trust be in a position to have income (meaning profits) to distribute? I am assuming if there is no profit the income can't be distributed or loans repaid.

If the trust owns a -ve geared property - it could be many years until rent exceeds rental expenses and trust fees. The trust would be in the red for a long time. It would owe money (as the shortfall in expenses would have to come from somewhere)
The rental losses can't be offset against personal income so no cash from tax savings can be put back into the trust. So the losses keep adding up.

This property may have good CG but that is equity and not income? (Unless you sell or use LOC)

The trust could buy a +ve geared property but its probably not +ve enough to cover the annual trust fees.

In twenty years time I can see that rents should be able to pay all expenses and fees and then there is income to distribute. Or there is equity in the Ips that can be released through a LOC or an IP can be sold and the income distributed.

But what about the first 5-10 years? Shortfall would come from personal income loaned to the trust? As the trust isn't profitable at this point then loan can't be repaid?



Am I missing something here?

 

[Aaron_C]

Yes, shortfall will have to come from the trust's own capital (from the beneficaries). Losses are trapped in the trust until it makes a profit. Don't forget that the loan can be repaid since the loan/interest repayments will be treated as expenses which impact on the trust's P&L. That is the downfall of a family trust - lack of negative gearing - for the benefit of a better/flexible tax treatment come CGT/positive gearing.

 

[Terry_w]

Thats basically correct. The trust is a separate entity for tax purposes so it will be running at a loss. Even positively geared property may still run at a loss because of non cash expenses.

This loss is not yours so cannot offset your income. Losses can be carried forward and be offset by future income of the trust. Add to the costs the extra land tax too.

You need to run the numbers carefully before deciding to buy. Do different scenarios and see if the negatives and positives balance out in the long run.

If you are self employed it is much easier as income can be diverted into the property trust so the trust loss from property can reduce the income from business and thereby save you tax.

 

[CHAOS]

So this is one of the downsides of owning the property in a DFT? If our strategy is for one of our incomes to be replaced with income from our property portfolio in 10 years time - this is probably unlikely to happen if buying in trust structure.

I can see our kids and grandkids in the future benefitting from us having the Trust - but at this point I am selfishly looking at how it works for us and how it will provide us passive income.

We are not self employed.

The risk in your own name though is that people can find out what you own and sue you and take the lot.

Is there such thing as personal indemnity insurance to cover you if sued personally?

 

[Aaron_C]

We are not self employed.

The risk in your own name though is that people can find out what you own and sue you and take the lot.

Is there such thing as personal indemnity insurance to cover you if sued personally?

If you are not self employed (and are not looking to be) then the benefits of a DFT diminish significantly. The true benefit of the DFT is the flexibility in income splitting and this is why almost all business operate under a DFT in some shape or form.

 

[Terry_w]

You have to run the numbers. In NSW just the land tax alone makes trust very costly. Imagine having a $500,000 worth of property in NSW and paying $8,000 pa in land tax every year.

 

[Terry_w]

If asset protection isn't an issue I would suggest you look at buying in your own name in VIC as this is the only state which allows one spouse to transfer to another spouse at full market value without stamp duty. This opens up a whole host of strategies which allows you to pay down non deductible debt much faster.

 

[RPI]

Just make sure you look at asset protection

 

[Xjas]

I feel your pain, I too am having trouble getting my head around the trust thing, it hard to know what is best but I am thinking along these lines for my IP purchases.

Purchase IP in a NSW land tax unit trust (since I'm purchasing in NSW).
this allows me to negative gear and to get the land tax threshold, this gives little to no asset protection but does allow future flexibility to transfer the units at a reduced stamp duty rate. The need for asset protection of a property at this stage would be minimal anyway since the property would be mortgaged at 90% LVR.

Once the IP yield is high enough that the income tax on the earning from it are more than land tax for the property then I would transfer ownership of the units to a discretionary family trust for asset protection and so I can distribute income to my (non working) wife (alternately I may transfer the units into a SMSF). There would be stamp duty to pay and CGT but making this change as early as practical should minimise these costs.


The issues I can see with my approach are;

1. As I acquire more properties I will go over the land tax threshold so for the value of property over the threshold I no longer need to wait until the earnings for an IP are over the land tax value before transferring it into the family discretionary trust because I'm paying that land tax regardless.

2. As interest rates fluctuate a property may be positively gear one year (and be transferred into a discretionary trust) then as interest rates rise it may become negatively geared, this is not a massive problem though as those losses are held by the trust to be offset in later years (or by other properties in the trust), no sure how this would go with a SMSF.

I'm sure others will pick holes in this approach

 

[Terry_w]

Once the IP yield is high enough that the income tax on the earning from it are more than land tax for the property then I would transfer ownership of the units to a discretionary family trust for asset protection and so I can distribute income to my (non working) wife (alternately I may transfer the units into a SMSF). There would be stamp duty to pay and CGT but making this change as early as practical should minimise these costs.

You wouldn't just transfer the units, but sell them at market rates to a discretionary trust. The money released could go to paying down your PPOR debt. But because the trust is buying income producing units the trust would be entitled to deduct the interest. In a round about way this enables you to pay down your PPOR loan and claim a deduction for it.

Stamp duty in NSW on the transfer of units is set to be abolished on July 1 this year (may not happen). CGT would be payable though.

Transferring to a smsf would only be possible if the property owned by the unit trust was not mortgaged.

 

[Terry_w]

The issues I can see with my approach are;

1. As I acquire more properties I will go over the land tax threshold so for the value of property over the threshold I no longer need to wait until the earnings for an IP are over the land tax value before transferring it into the family discretionary trust because I'm paying that land tax regardless.

2. As interest rates fluctuate a property may be positively gear one year (and be transferred into a discretionary trust) then as interest rates rise it may become negatively geared, this is not a massive problem though as those losses are held by the trust to be offset in later years (or by other properties in the trust), no sure how this would go with a SMSF.

I'm sure others will pick holes in this approach

If you have reached the land tax threshold then why not just buy in a unit trust with the units held by a discretionary trust for asset protection. Units could later be sold to another discretionary trust to release equity maybe.

If units are held by a SMSF there would be no borrowings so interest rates wouldn't be a worry.

You should also ideally just hold one property per unit trust for several reasons, asset protection, land tax, stamp duty, SMSF transfers etc.

Also consider using other states. Get access to separate thresholds for land tax. I also tell all clients to consider VIC because of the stamp duty laws down there. In own name - spousal sale strategies.

 

[nathank]

one way to do it, is to buy the property in a fixed unit trust (FUT) and claim the negative gearing now. As the property reaches cash flow positive, you can sell those units to a DFT and then distribute the income.

You do have a CGT event to consider when you 'sell' the units to the DFT (or a SMSF), but it will help you get to your end game.

For the land tax in lovely nsw, there are specific trust structures that have been ok'ed by the OSR to get their own land tax threshold. A few people here can help you with those trusts if you want to go down the FUT path.

 

[Terry_w]

one way to do it, is to buy the property in a fixed unit trust (FUT) and claim the negative gearing now. As the property reaches cash flow positive, you can sell those units to a DFT and then distribute the income.

You do have a CGT event to consider when you 'sell' the units to the DFT (or a SMSF), but it will help you get to your end game.

For the land tax in lovely nsw, there are specific trust structures that have been ok'ed by the OSR to get their own land tax threshold. A few people here can help you with those trusts if you want to go down the FUT path.

And any CGT can be reduced by gradually transferring the units. ie over more than 1 financial year.

 

[Xjas]

If you have reached the land tax threshold then why not just buy in a unit trust with the units held by a discretionary trust for asset protection. Units could later be sold to another discretionary trust to release equity maybe.

May still need negative gear though, which I understand I couldn't do if the units were held by a discretionary trust.

I didn't realise you couldn't have a mortgage with a SMSF but it make sense, I guess transfering to SMSF is something thats done much later in the invesment journey but buying in a unit trust is a good way to prepare for that.

 

[Aaron_C]

I didn't realise you couldn't have a mortgage with a SMSF

You can have a mortgage with a SMSF but it is structured a bit differently.