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Basic (silly) investment questions

Discussion in 'Accounting, Tax & Legal' started by investitor, 15th Feb, 2007.

  1. investitor

    investitor Member

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    Hello,

    I'm really, really new to the investment world and have a few questions.

    While I'm coming from a family with no investment tradition, I've been lucky enough so far and managed to start what appears to be a good career. I am now married and have a baby, and I guess it's time to start being wise with money and get educated about investing it the right way. I read a few books that really changed my perspective on things (Rich Dad, Poor Dad was the one that had greatest impact on me), opened my eyes and made me realize that I am not at all prepared for this.

    I am on a pretty good income (around $100k/year before tax), and my better half is on around $60k before tax. We have just bought our PPOR in our names and took advantage of the FH benefits. Debit-wise we have the mortgage and a personal loan for one of our cars, and so far have been paying the credit in full each month. The only other major expense is child care/education.
    We are still young, so our super has just started. Right now we have around 20k in redraw and choose to use any spare money to make additional repayments to our PPOR.
    However, this doesn’t do a thing for our taxes. Only one of us (me) get to claim car expenses, but that’s pretty much it. We are paying a lot of tax, and I realized there are better ways to use that money.

    Here is where the questions start:
    1. I heard a lot about the benefits of family/discretionary trusts. Would they allow us to transfer our income (salaries) into the trust and then distribute it?
    2. If so, what is the mechanism of transferring the income to the trust?
    3. If not, how does a trust help with lowering the tax obligations? Do we need to use post-tax money to loan/gift it to the trust and then acquire assets in the trust and then claim expenses/deductions associated with that asset?
    4. What are some basic strategies to better use our money?

    I realize we need a good accountant, please don’t tell me that! However, before speaking to one I probably need to get a better grasp of the different options available, and then talk to someone that can provide detailed information about what is best suited for us. Btw, does anyone know a good accountant in ACT ? We are in neighbouring NSW.

    Thank you.
     
  2. iiinvestor

    iiinvestor Well-Known Member

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    investitor:

    Remember that you're not meant to use trust structures to avoid tax, they're designed for asset protection. So while you may want to avoid tax in reality, try to re-word it when talking to your accountant or the tax man. Some accounts are pretty conservative, so they won't want to help you purposely avoid tax.

    As for your more specific questions, there are others here more qualified to answer.
     
  3. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    No - there is no direct tax savings to be had from trusts in relation to your salaries. The only real tax saving mechanisms you have available to you are negative gearing, legitimate work expense deductions, and salary sacrifice.

    See above.

    Yes - but it doesn't help with your personal income unless you use an advanced trust mechanism (like a Hybrid Discretionary Trust) to hold negatively geared assets. If your assets make you money (which should always be your long term goals), then there is no tax benefit to be had.

    The main tax benefit from discretionary trusts is in the flexibility that you get in deciding who will pay the tax on the proceeds from your investments. You get the discretion to stream income to the person in the lowest tax bracket - thus saving some money.

    There's no magic tax saving in trusts when it comes to personal salaries.

    1. pay down your non-investment debt ASAP (that includes your PPOR - but focus on the debt with the highest interest rate first - your car !!)

    2. invest in growth assets

    That's about all there is !!

    I'm not a fan of negative gearing for the sake of tax benefits - I prefer to invest for the purpose of making money - if there are tax benefits to be had from those investment, that's a bonus, but not the goal.

    Trusts are primarily asset protection vehicles - there are some tax benefits to be had, but that is not usually the prime reason for using them.

    You should read up on Hybrid Discretionary Trusts - it may be what you are looking for - but you don't necessarily need one to achieve what you want.

    Hope this helps.
     
  4. iiinvestor

    iiinvestor Well-Known Member

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    Sim:

    Could you please explain how an HDT allows you to pass on losses from the trust to a beneficiary (if that is in fact what happens)? I've had debates with an accountant/lawyer friend and he assures me it's not possible. I don't know if he isn't well-read on HDTs or if he's right and I'm wording it incorrectly.

    Thank you
     
  5. investitor

    investitor Member

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    Wise structuring is not tax avoidance, is it?

    Thanks for that. I do not intend to use a trust for the sole purpose of avoiding tax. I'm just trying to get educated about the benefits of different structures, including trusts. It would be really bad if I were to find out down the track that I was able to claim certain deductions under one structure, but did not do it for lack of knowledge. The long term goal is prosperity, so getting information is really important at this stage.

    Am I mistaken if I believe that any money that goes into an income-generating investment rather than tax ultimately generates more taxable income, therefore tax?

    Thanks!
     
  6. investitor

    investitor Member

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    That sounds like good advice. I'm just wondering what all those people on the forum that pay under 5% tax are doing :)
     
  7. iiinvestor

    iiinvestor Well-Known Member

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    Seriously... by losing money :D Either depreciation and losses have reduced their taxable income, or they're employing a tax saving scheme that passes on large enough paper losses to offset most of their income (like investments in tree plantations).

    Losing money in the form of interest payments and depreciation may not be so bad during the acquisition and growth phase of your portfolio. But as Sim said, it's probably not the best to focus on tax savings.

    If you go out now and buy a couple of properties and invest in a few growth funds, you'll more than likely be running at a loss. The reason is that while you hope these investments make more money than you have to spend (on interest, maintenance, etc), they do so in the form of capital growth. Since you won't sell those investments for a long time, you won't see the growth in cash form. So the way the tax man sees it is that you're spending all of this money and getting nothing back (for now). Hence you can write those losses off. Essentially if you never sell, you never have to pay additional tax (until the rent or dividends or distributions start to outweigh the losses, but that may take a while).

    So you can lose lots of money for years on end, but really be making a lot too in the background that the tax man turns a blind eye to (until you sell).
     
  8. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    I'm not an expert in HDT - I prefer the good ol' ordinary Discretionary Trust myself.

    ... but I think it is terminology to a degree ... the HDT doesn't really "pass on losses" ... no trust can do that. You get the benefit because you have purchased units in the "unit trust" part of the structure in your own name, and you get to claim negative gearing benefits from the costs you incur in doing so. That part of it is no different to if you had bought an IP in your own name and claimed the negative gearing benefits.

    As I said, I'm no expert in this area - so I'm prepared to be corrected about the details here.

    You really need to understand how HDTs work to appreciate the subtleties. You also need to make sure you go to an accountant who is an expert in these structure - most accountants don't understand them and will recommend you don't use them (because they don't understand). Not all HDTs are created equal.

    Hopefully some of our more expert members can add more detail about HDTs.
     
  9. Nigel Ward

    Nigel Ward Team InvestEd

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    Investitor

    The way a HDT works (let's use buying an investment property as an example) is that:

    a) you borrow money from the bank
    b) you use the money to buy units from the trust which entitle you to receive an income distribution
    c) the trustee uses your money to buy the property in its name
    d) the trustee gets the property related expenses and thus deductions eg. rates, land tax, repairs, depreciation and also receives the property income i.e. rent
    e) you get to claim the interest on the loan as a deduction against your other taxable income - the reason this is deductible is that you've used the money to buy and income producing asset, namely the units.

    In this way you get the lion's share of the deductions involved with an IP personally but also the flexibility of having the asset in a trust. Now whilst you own the units income will need to come to you but (depending on the terms of the trust and the units' terms of issue) there will be flexibility in relation to distribution of some income down the track and more importantly in capital gains on sale. BUT as Sim' mentioned, asset protection is also a key advantage by removing ownership of the house from you.

    Hope that helps.

    Cheers
    N.

    btw there's a good two-part series of articles explaining hybrid trusts in the last two Australian Property Investor magazines by DaleGG (one of our members).
     
  10. iiinvestor

    iiinvestor Well-Known Member

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    Thanks for the explanation Nigel

    From point d), does that mean if the trustee is an individual, they get to offset those expenses against their personal taxable income?

    Also (and this may depend on the deed), how does ownership of trust units in an HDT affect distributions. Do the people who own units have to be given x% or $x of income and then the rest is distributed by discretion?

    Is there any way we can access those articles on the net?

    Sorry for all of the questions, I'm just trying to get this right. :)

    Thank you
     
  11. Nigel Ward

    Nigel Ward Team InvestEd

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    My thoughts below.

     
  12. Redwing

    Redwing Well-Known Member

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    iinvestor

    Dale has a great book out called "Trust Magic"..best of all its written in a format even I can understand ;)

    Gatherum-Goss & Assoc.

    I have the Following Books on Trusts (from Memory)
    1 -Dale GatherumGoss's Trust Magic
    2- Ed Burtons Bulletproof Asset Protection
    3- Chan and Naylors "How to legally Reduce your Tax"
    4- Nick Rentons book on Trusts

     
  13. Nigel Ward

    Nigel Ward Team InvestEd

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    Redwing is right. Dale's book is very good. My thoughts on Redwing's Trusts library are above.
     
  14. iiinvestor

    iiinvestor Well-Known Member

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    Many thanks Redwing, I'll check those out.
     
  15. Meggsy

    Meggsy Well-Known Member

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    Read this one about two weeks ago, it posed more questions for me than it answered. Then again, maybe that is a good thing - it encouraged me to read more about the topics.
     
  16. iiinvestor

    iiinvestor Well-Known Member

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    There's an article on trusts in this month's Smart Investor (p65) for anyone interested.

    As for API, I bought the Feb issue today and just ordered the back issue. So here's hoping all will be revealed.
     
  17. Jacque

    Jacque Team InvestEd

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    I've found Dale's books to definitely be the easiest to read, as he writes in a common language easily understood by those of us who don't speak in accounting terms on a daily basis :D