What giving up the CGT exemption on your PPoR really costs!

[Jonathon]

I've been helping a colleague crunch some numbers on the decision whether to buy her PPoR in her name or a trust, as she receives trust distributions which she has to pretty much absorb herself at approx 40%.

Very round numbers at this stage, a $1m property, buying in the trust name and renting at a market rent will save her about $20k per year, compared to buying in her name and paying tax on her trust income.

So, how does she weigh up that $20k saving each year against the loss of the full CGT exemption. Naturally when I asked her what growth she expected in the value of the house, I got the usual "oh it'll double every 7-10 years", but going with a more realistic 5% compound growth, if she sells in 10 years time, she's looking at a capital gain of $629k, with $126k of tax payable, assuming she distributes at 40%.

On these numbers, it's a no brainer, a $20k pa saving is clearly worth more than $126k in 10 years time, more like about $330k, assuming a WACC of 7.5%.

But, when I then modelled 10% price growth, the numbers came out a lot more evenly, with a CGT payment of $319k in 10 years time.

Obviously there are many more considerations than just the CGT exemption, but I found it interesting to model it out…didn't help her decision-making though!

Having said all that, a bird in the hand...particularly if we get a period of stagnating prices. (No I'm not a doomsayer!!!)

Cheers
Jonathon

 

[Gools]

I guess they could get rid of negative gearing exemption too and we could have really strong growth. Then the shoe would be on the other foot.

 

[jrc77]

I've been helping a colleague crunch some numbers on the decision whether to buy her PPoR in her name or a trust, as she receives trust distributions which she has to pretty much absorb herself at approx 40%.

Very round numbers at this stage, a $1m property, buying in the trust name and renting at a market rent will save her about $20k per year, compared to buying in her name and paying tax on her trust income.

Jonathon,

I'm a bit confused - are you saying this friend receives a distribution as the beneficiary of the trust and is looking at buying a PPOR inside the trust to reduce the amount of money distributed (and hence paid tax on?)

Regards,

Jason

 

[Jonathon]

Jonathon,

I'm a bit confused - are you saying this friend receives a distribution as the beneficiary of the trust and is looking at buying a PPOR inside the trust to reduce the amount of money distributed (and hence paid tax on?)

Regards,

Jason

She receives income as a beneficiary of another trust, i.e. her trust receives income from another trust. She will buy a property inside her trust, not the trust making the distribution.

 

[dr.jauncey]

She receives income as a beneficiary of another trust, i.e. her trust receives income from another trust. She will buy a property inside her trust, not the trust making the distribution.

Hi, is she talking then about using a unit or hybrid trust to negatively gear her own home or redirecting the other trust distribution to the new trust?

If the former, she will need to be careful not to fall foul of this ruling.

If the latter, she will need to be careful not to fall foul of the law of perpetuities.

Any hints to provide for further discussion?

 

[Jonathon]

The latter, she's planning on holding the property in a discretionary trust, of which she's a beneficiary, and is looking at this ruling.

Admittedly that ruling was based on a trust holding the property as an IP before renting it to the beneficiary, but as long as the rent received by the trust is commeriial, I can't see that it would matter.

What's impact of the law of perpetutities on this situation?

 

[Jonathon]

Just to clarify a little on the situation - she is trustee of a family trust which receives income from a service trust associated with her husband's professional work. As she is earning circa $100k in salary from work, with no kids, she distributes the family trust's income to herself, and hence gets taxed at 39.5%.

Of course she could park the distributions in a corporate beneficiary at 30%, (or at least she could prior to the latest ATO interpretation, now she'd have to actually pay it over) try to distribute to low income relatives, etc, but she tends to just declare it herself.

 

[dr.jauncey]

Admittedly that ruling was based on a trust holding the property as an IP before renting it to the beneficiary, but as long as the rent received by the trust is commeriial, I can't see that it would matter.

What's impact of the law of perpetutities on this situation?

Just to clarify a little on the situation - she is trustee of a family trust which receives income from a service trust associated with her husband's professional work. As she is earning circa $100k in salary from work, with no kids, she distributes the family trust's income to herself, and hence gets taxed at 39.5%.

Hi, the possible concern with the law of perpetuities would be if the vesting date of the property trust is later than the vesting date of the service trust that is distributing to it. Just a thought to consider.

For the record I would also agree that if the property is leased to a related party on commercial terms and is regularly reviewed then the tax office should not have concern with that side of the arrangement.

 

[Terryw]

I've been helping a colleague crunch some numbers on the decision whether to buy her PPoR in her name or a trust, as she receives trust distributions which she has to pretty much absorb herself at approx 40%.

Very round numbers at this stage, a $1m property, buying in the trust name and renting at a market rent will save her about $20k per year, compared to buying in her name and paying tax on her trust income.

So, how does she weigh up that $20k saving each year against the loss of the full CGT exemption. Naturally when I asked her what growth she expected in the value of the house, I got the usual "oh it'll double every 7-10 years", but going with a more realistic 5% compound growth, if she sells in 10 years time, she's looking at a capital gain of $629k, with $126k of tax payable, assuming she distributes at 40%.

On these numbers, it's a no brainer, a $20k pa saving is clearly worth more than $126k in 10 years time, more like about $330k, assuming a WACC of 7.5%.

But, when I then modelled 10% price growth, the numbers came out a lot more evenly, with a CGT payment of $319k in 10 years time.

Obviously there are many more considerations than just the CGT exemption, but I found it interesting to model it out…didn't help her decision-making though!

Having said all that, a bird in the hand...particularly if we get a period of stagnating prices. (No I'm not a doomsayer!!!)

Cheers
Jonathon

Hi Jonathan

Did you also factor in rising rents during this period too? ie the rent she pays the trust would have to be market rent which would be increasing year by year.

On the other hand her trust could probably furnish the house too and charge a slightly higher rent with the trust claiming depreciation etc.

 

[Jonathon]

Terry

You've hit the nail on the head there. The issue is that most of the expenses are nominal (principally interest) but the income will increase with inflation, so a $20k saving each year at the moment might only be a $15k saving in 5 years time.

This is somewhat offset with ongoing expenses, rates, land tax, cleaning/gardening etc, and of course if it's a property with a lot of depreciation, either div 40 or 43, then that helps too