Summary of my HDT thoughts...
Julia, thanks for your comments and replies in relation to the HDT. That is exactly what I was after on this forum, ie, an alternative point of view/opinion/interpretation of the HDT - which will help others here make more informed choices. Though this is obviously no substitute for paid professional advice, it is a good starting point.
Here I will try and summarise my ramblings about the HDT!
If you believe that in the situation where the SIU holder, with 200k of SIU's used by the trust to buy a 200k IP, to create a negative gearing position for the SIU holder, should...
(1) Be entitled to capital rights.
(2) Have their SIU's valued at the same price as the IP in question.
And, if the ATO agrees with this view, then I think the HDT may offer no overall advantage to purchasing in one's own name, and may perhaps be disadvantageous, as there may be a smaller pool of lenders willing to lend with a HDT involved.
However, we are talking specifically here in regards to a special class of income - SIU's with negative gearing for IP's.
So, I would think that the HDT could still be used beneficially like a normal DT, for other types/classes of income/investments.
Now, the alternative point of view is that you believe that the SIU holder is rightfully only entitled to income (including capital gains, but not capital), according to the trust deed.
So now the question becomes...
(1) How do you justify paying 200k for these income units, with no capital rights? This is far more than what they are really worth - how do you justify 'over-paying' for the SIU's in this way?
Now I understand there is this concept of 'net present value with a terminal value' and the 'market substitution rule' which has been mentioned on this forum before, and has relevance here. I know nothing about this, so can't really comment, but will read up on it.
Putting this aside, using some basic financial sense, I guess you could justify this 'over-paying' by some of the following:
(1) Over the long-term, rental income will become much more than the interest expense with inflation/greater rental demand/capital growth of the property.
(2) The property can be value-added to significantly increase the rental income, eg, by renovation, development, change of use/zoning, multi-letting.
(3) The principal of the loan can be repaid, thus increasing net rental income.
(4)The investment/risk profile of the residential property asset class make it very suitable to provide an income stream for a wide range of people.
If you follow this reasoning, I think the key things to then note are:
(1) All income (including capital gains) while SIU's are on issue, must be distributed to the SIU holder.
(2) If SIU's are redeemed, this should occur at a point when rental income is greater than interest expense, ie, when the SIU holder is positively geared.
(3) The redemption price should be at an appropriate and justifiable market value.
(4) After SIU's are redeemed, there should be a 'reasonable time lag' before discretionary distribution of income (ie, 'income splitting) to beneficiaries occurs.
Now, if SIU's are redeemed at a point when rental income is still much less than interest expense, and if the redemption occurs at a market value that results in minimal CG to the SIU holder, then in this instance, it may be possible that all the interest expense incurred may be disallowed by the ATO.
Alternatively, if the property is firstly sold, then the SIU's redeemed after this, at a market value that results in minimal capital gains to the SIU holder, at a point when rental income is still much less than interest expense, and the property itself is sold with minimal capital gains, then in this instance, it may be possible that all the interest expense incurred may be disallowed by the ATO.
The question to ask then is why would you have to redeem SIU's at a point where rental income <<< interest expense???
This may be if the trust/'you' is forced to sell the property much sooner than expected or when there has been minimal capital growth to the property.
This for me would then be the real risk to the HDT.
However, if you are confident that you will not or won't have to sell the property pre-maturely, and will hold for the long-term, then this should not really be a problem. And subsequently, the HDT may be entirely appropriate for you. So it would appear to me to be that the HDT could be very suitable for a long-term buy and hold investor in property, and even more so to people with secure jobs/incomes.
A possible exception to note is that if there was a major renovation or development to the property, even if it was in a short-time frame, this may generate sufficient income (in the form of capital gains) to the SIU holder to justify the negative gearing losses, and make the interest expense an allowable deduction.
Overall, despite my critical comments, I still think the HDT can work, more so if the 'conservative' interpretation of it is adopted. The only sticking point for me is the initially 'overpaid price' of the SIU's and NPV/terminal value/market subsitution rule, which I will try and resolve for myself.
I suspect that in court, a good trust/tax lawyer could potentially argue each point of view equally well.
Dale's comment below is very fitting:
Hope this has helped!
GSJ
Hi,GSJ,
That's right, at worst no negative gearing for the whole time of the investment plus penalties.
So the question is are HDTs worth the risk when there are usually other ways of achieving the same end and they are cheaper.
I'm am not saying HDTs "will fail". I really don't know for sure. It is the uncertainty that I am pointing out, that is why any clients who are determined to use them I send to a specialist.
Julia
www.bantacs.com.au
Julia, thanks for your comments and replies in relation to the HDT. That is exactly what I was after on this forum, ie, an alternative point of view/opinion/interpretation of the HDT - which will help others here make more informed choices. Though this is obviously no substitute for paid professional advice, it is a good starting point.
Here I will try and summarise my ramblings about the HDT!
If you believe that in the situation where the SIU holder, with 200k of SIU's used by the trust to buy a 200k IP, to create a negative gearing position for the SIU holder, should...
(1) Be entitled to capital rights.
(2) Have their SIU's valued at the same price as the IP in question.
And, if the ATO agrees with this view, then I think the HDT may offer no overall advantage to purchasing in one's own name, and may perhaps be disadvantageous, as there may be a smaller pool of lenders willing to lend with a HDT involved.
However, we are talking specifically here in regards to a special class of income - SIU's with negative gearing for IP's.
So, I would think that the HDT could still be used beneficially like a normal DT, for other types/classes of income/investments.
Now, the alternative point of view is that you believe that the SIU holder is rightfully only entitled to income (including capital gains, but not capital), according to the trust deed.
So now the question becomes...
(1) How do you justify paying 200k for these income units, with no capital rights? This is far more than what they are really worth - how do you justify 'over-paying' for the SIU's in this way?
Now I understand there is this concept of 'net present value with a terminal value' and the 'market substitution rule' which has been mentioned on this forum before, and has relevance here. I know nothing about this, so can't really comment, but will read up on it.
Putting this aside, using some basic financial sense, I guess you could justify this 'over-paying' by some of the following:
(1) Over the long-term, rental income will become much more than the interest expense with inflation/greater rental demand/capital growth of the property.
(2) The property can be value-added to significantly increase the rental income, eg, by renovation, development, change of use/zoning, multi-letting.
(3) The principal of the loan can be repaid, thus increasing net rental income.
(4)The investment/risk profile of the residential property asset class make it very suitable to provide an income stream for a wide range of people.
If you follow this reasoning, I think the key things to then note are:
(1) All income (including capital gains) while SIU's are on issue, must be distributed to the SIU holder.
(2) If SIU's are redeemed, this should occur at a point when rental income is greater than interest expense, ie, when the SIU holder is positively geared.
(3) The redemption price should be at an appropriate and justifiable market value.
(4) After SIU's are redeemed, there should be a 'reasonable time lag' before discretionary distribution of income (ie, 'income splitting) to beneficiaries occurs.
Now, if SIU's are redeemed at a point when rental income is still much less than interest expense, and if the redemption occurs at a market value that results in minimal CG to the SIU holder, then in this instance, it may be possible that all the interest expense incurred may be disallowed by the ATO.
Alternatively, if the property is firstly sold, then the SIU's redeemed after this, at a market value that results in minimal capital gains to the SIU holder, at a point when rental income is still much less than interest expense, and the property itself is sold with minimal capital gains, then in this instance, it may be possible that all the interest expense incurred may be disallowed by the ATO.
The question to ask then is why would you have to redeem SIU's at a point where rental income <<< interest expense???
This may be if the trust/'you' is forced to sell the property much sooner than expected or when there has been minimal capital growth to the property.
This for me would then be the real risk to the HDT.
However, if you are confident that you will not or won't have to sell the property pre-maturely, and will hold for the long-term, then this should not really be a problem. And subsequently, the HDT may be entirely appropriate for you. So it would appear to me to be that the HDT could be very suitable for a long-term buy and hold investor in property, and even more so to people with secure jobs/incomes.
A possible exception to note is that if there was a major renovation or development to the property, even if it was in a short-time frame, this may generate sufficient income (in the form of capital gains) to the SIU holder to justify the negative gearing losses, and make the interest expense an allowable deduction.
Overall, despite my critical comments, I still think the HDT can work, more so if the 'conservative' interpretation of it is adopted. The only sticking point for me is the initially 'overpaid price' of the SIU's and NPV/terminal value/market subsitution rule, which I will try and resolve for myself.
I suspect that in court, a good trust/tax lawyer could potentially argue each point of view equally well.
Dale's comment below is very fitting:
And I think Rolf Latham summed it up the best with this great line:...the uncertainty is part of the beauty of tax law and creates the opportunities that we all seek to reduce our tax...
Please note that my thoughts on the HDT are purely based on readings from this forums posts, and I have no professional qualifications to talk with any real authority on this subject! I'd encourage anyone to pick holes/flaws in my arguments! And also speak to your own advisors about the HDT, as I am about to!...If you don't like risk, don't play at the edges...!
Hope this has helped!
GSJ
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