Join our investing community

Discretionary Family Trust - Best way to go halves in buying an IP?

Discussion in 'Accounting, Tax & Legal' started by Sk3tChY, 13th May, 2011.

  1. Sk3tChY

    Sk3tChY Well-Known Member

    Joined:
    4th Aug, 2007
    Posts:
    358
    Location:
    Sydney, NSW
    Currently in the market for my next IP, but have found a couple of properties that have really piqued my interest.

    Getting the funds to buy 2 on my own probably wouldn't be possible because it would be a large loan of about $900,000+ and even though I'm young had would have at least a 20% deposit down on all the properties, should they be vacant for any period of time it could become very hard for me to service the loan and I'd say serviceability or lack thereof is what would prevent me from borrowing such an amount.

    Not only that, but I'd be so heavily geared that some of the deductions I'd be claiming would start being at just 15%, which isn't exactly ideal.

    A friend of mine told me a little about Discretionary Family Trusts and I must say from what he told me, they sound great!

    I was told a few things about them and was hoping someone could clarify whether they're true or not:

    1. Rather than you being held solely responsible for a loan, it holds the trust and therefore all the people within it responsible for the loan. This means the lender takes into account the combined incomes, assets and expenses of all the people within the trust when determining your borrowing power.

    So for example if myself and mother were in a Discretionary Family Trust and wanted to get out a loan, it would take into account both her assets/income/expenses as well as mine, and because she owns her own home and has no expenses and I'm young and work full-time, together it would give us some decent borrowing power.


    This would be very beneficial for me as it would give me/us the borrowing power to buy the extra IP. Mum is getting old so banks are reluctant to lend her much money, and on the flip side I'm young but would already have a fairly large loan myself. Together however we shouldn't have any issues servicing the small loan, especially with an IP that is basically in the green from the get go. Essentially a trust would solve both our issues, she needs youth and I need equity.

    2. When it comes to taxing the profit made by a trust, if it's a discretionary trust (are there any other kinds?) you can choose to allocate the income to whomever you see fit.

    So for example if someone within the trust was unemployed for that entire financial year and your assets made a profit of $6000 for that financial year, you could choose to allocate that amount to the unemployed person for that year and therefore pay no tax on it.


    Probably not all that beneficial in the short term as the property would be slightly in the red or making a very small amount of profit, but in the later years this could prove to be a very efficient option to have, especially when my mother comes to retire. We could potentially allocate all the IP income to her and pay very little tax on it as opposed to it being tacked onto mine and getting taxed at 30%+.

    3. When your investments within a trust make a loss you can't claim them as tax deductions to people within the trust. Instead they just get offset against gains when the trust finally starts making gains.

    This wouldn't be that big an issue in our case, because the property we'd be buying would either be making a very small amount of money straight away or only be slightly in the red for the first year or two.

    Are these points indeed true? Is there any downside to having a trust like this?

    4. Would anyone be better off buying a property with a joint home loan instead of via a trust, and getting multiple names on the deed?

    My understanding is that if you do things this way you don't get the option to pick and choose how much income gets allocated to each person, instead they get determined on how much of a % you claim each person owns on the deed.

    One thing that 'could' be considered advantageous that I can see is that you would be able to claim tax deductions on losses you make.

    In the short term could be considered beneficial, however in the long term or in the case where you have a property that is or would be making profit very early, it probably wouldn't make much of a difference because in a trust it would just offset and you'd essentially get the same savings.


    Very keen to learn a little more about these trusts as opposed to simply have joint loans and multiple names on the deed.

    Lastly - If most of what I've been told is true and doing things via a Trust is indeed the best way to go, how/where exactly would I get all this set up? An accountant? solicitor? bank? Would I just get the forms from somewhere and send them in or something?

    Big thanks in advance to any of you that post your opinions, they're all greatly appreciated. I'll be sure to keep everyone updated on my investment ventures once I get everything sorted. :)
     
  2. jrc77

    jrc77 Well-Known Member

    Joined:
    26th May, 2008
    Posts:
    147
    I'll start by saying that I don't have a house in a trust, but I do have two trusts for business and investments, so have researched them quite a bit.

    When applying for the loan I would expect that the bank would look at the income of the trust (presumably only the rent on the property). For this reason, a high LVR would normally not be that likely for the loan.

    If extra income was required then I would expect that the person providing it would need to go guarantor for the loan - in your case both the parties would need to go guarantor and would be joint and severely responsible for the loan.

    One of the loan brokers could provide clarification.


    This would be very beneficial for me as it would give me/us the borrowing power to buy the extra IP. Mum is getting old so banks are reluctant to lend her much money, and on the flip side I'm young but would already have a fairly large loan myself. Together however we shouldn't have any issues servicing the small loan, especially with an IP that is basically in the green from the get go. Essentially a trust would solve both our issues, she needs youth and I need equity.

    There are lots of other types of trusts. Read about Unit Trusts and Hybrid Discretionary Trusts (but be careful with these).

    Yes - distributing capital gains and income to different beneficiaries of the trust is a major advantage.

    This is true and can be a disadvantage. Could get around it if you have other business/trusts that can distribute a profit to the property trusts to offset the loss. Also if you expect the property to be positively geared sooner rather than later then it might be OK.

    Other big downside is that there are no land tax free threshold for trusts in all states except Queensland (last time I checked anyway).

    So in NSW, purchasing a house that had a land value component of $200,000 (say a $500-600k unit for example) would costs you $3200 a year in land tax.

    For this reason alone, I am probably not going to look at buying a property in a trust until I have exhausted the land tax free threshold in both my wife and my name, in several different states. This is because the land tax free threashold is calculated for each individual/entity based on the total land value of any property they have a part or full ownership of. So if you buy a IP in joint names, it will count towards both peoples land tax thresholds. Incidently I read a story recently of a couple who bought five investment properties all in joint names and are now getting hit with a large land tax bill - and are faced with large CGT/stamp duty bills to transfer them to individual names.

    Additionally you would be likely to have additional accounting costs.

    There are some good books on Trusts - I suggest that you find one and have a good read. I read one by Nick Renton and found it quite enlightening. There is also a online PDF one called Trust Magic which I have heard is quite good.

    Personally I would suggest an accountant who is familiar with Trusts to get one setup.

    Good luck with your research. Trusts can be extremely beneficial - just make sure you are aware of the downsides as well as the advantages.

    Regards,

    Jason
     
  3. Sk3tChY

    Sk3tChY Well-Known Member

    Joined:
    4th Aug, 2007
    Posts:
    358
    Location:
    Sydney, NSW
    I figured a family trust was kind of like grouping everyone under the one entity, but from what you're saying it kind of sounds like it's creating a completely new, completely seperate entity?

    i.e. It's treated in it's own right rather than by the people within it. Even though the people within it may earn a combined income of $100,000 and have $500,000 worth of equity that doesn't mean 'the trust' is considered to have that income and equity.

    Correct?

    Which is interesting; hypothetically does this mean if a loan was acquired via a trust without any individuals guarantoring and they defaulted on that loan, would the bank be able to touch any of the assets owned by members within the trust?

    Example: Say me and mum started this family trust and bought this IP through it without individually guarantoring. If for some reason the investment turned sour and we couldn't pay off the loan, what would happen? Would the bank be able to come after our individual assets or would they only be able to touch assets that "the trust" owns?

    Land tax? I've owned an IP for a few years now and never paid or even heard of land tax before. What's this? :confused:

    I see. Does a trust need to submit its own tax return or something? I figurd it may have just made the individual tax returns of the people within the trust a little more complicated.

    i.e. If the trust made a profit of $5,000 and that was going to be allocated to me for that year that I'd simply have to specify it on my tax return.

    Although thinking about it now, I'm under the assumption that something would need to be submitted, somewhere and to someone specifying the total income the trust made and to whom that income was allocated.

    I probably should try and find the time to do that, it would probably answer a lot, if not all of my questions.

    Trust Magic looks fairly interesting, $61 or something for the PDF, might be worth having a squiz.

    Plus since it's for investment purposes it would be deductable too! :p

    Right, so an accountant is what I'm after, cheers.

    I just wasn't too sure if I should be looking for an accountant or a solicitor. An accountant makes a little more sense though.

    Thank you for the help thus far mate, I really apprecite the help.

    As stated above, my best bet would probably be to just get my hands on something like Trust Magic and have a read.
     
  4. jrc77

    jrc77 Well-Known Member

    Joined:
    26th May, 2008
    Posts:
    147
    That's correct.

    This is the asset protection side of the trust. My understanding is that they could only come after the trustee of the trust - which is why you can set up a corporate trustee (a $2 company) so that they can't come after you as trustee.

    It is also why the bank won't lend as much to a trust as a individual - so they will want to keep the LVR lower.

    You probably won't have to pay land tax yet because you have not exceeded your land tax free threshold. Do some reading at "http://www.osr.nsw.gov.au/taxes/land/rates/". It will be very important if you are looking at building up a big property portfolio. Also do some reading about the best way to purchase properties under different names/entities to reduce land tax - it can make a huge difference to your land tax commitments.

    A separate tax return must be done for the trust.

    Regards,

    Jason
     
  5. Dolfinwise

    Dolfinwise Well-Known Member

    Joined:
    30th Sep, 2009
    Posts:
    47
    Location:
    Brisbane
    Using Trusts to buy with other parties

    Buying property through any structure with other parties brings added complexity and risks. If the circumstances of one party change through illness, marriage. death or just the effluxation of time then the whole arrangement can be or can need to be unwound. With illiquid assets such as property this can be messy and expensive so great care has to be taken.

    When people are at different life stages this is particularly fraught and I have seen examples where people have missed out of huindreds of thousand of dollars of aged pension, lost inheritances, and paid tens of thousands of extra tax because unexpected circumstances arose that had not been thought through when jointly owning property.

    It is critical to fully understand everything that could go wrong and having a game plan to deal with it before buying property with other parties as your not only exposed to your own risks but potentially every risk that the other party is or will be exposed to as well.

    These risks include but are not limited too, relationship breakdown, ill health, death, business failure, business partnership breakdown, loss of license, loss of job, legislative changes, market risks, interest rate risks ......

    If I sound negative its because I have seen so many of these situations unravel to the detriment of one or both parties due to unforeseen circumstances. Its much wiser most of the time to invest on ones own within one's means.
     
  6. Sk3tChY

    Sk3tChY Well-Known Member

    Joined:
    4th Aug, 2007
    Posts:
    358
    Location:
    Sydney, NSW
    Intriguing. How would you setup a corporate trustee? Is this basically just where you would nominate a business/compnay through its ABN/ACN rather than an individual as the trustee?

    How low are we talking here? If we do decide to go ahead with setting up a trust and buying a property in the trust name, ideally we'd be putting down a 20% deposit and looking for 80% loan.

    Thanks a lot for that info! I'm under the $387,000 threshold which is why I've never had to worry about land tax I guess.

    From what I've managed to gather thus far though is if we purchase the property via a Trust we don't get this tax free threshold? Is this correct?

    So basically regardless of what we do or don't own as individuals, even if the property we have through the trust is the only property we own and well under the threshold, because it's in a trust we'd still have to pay 1.6% on $0-$2,366,000?

    If that's the case, you're right; that is a pretty big downside.

    Very true! Which is why I'm trying to do some research before even going to speak with an accountant first.

    From what I'm managing to gather, holding things in a discretionary family trust shouldn't impact the individuals within it very much, or even at all should you choose it not to.

    The individuals within the trust don't actually own the asset, the trust does. Meaning they shouldn't be knocked back for certain benefits for owning too much.

    And since you can arbitrarily allocate the income of the trust to whomever you see fit within the trust, that shouldn't affect them either.

    This is a major concern of mine though. If we do decide to go this route it would be my mother and I in the trust and in 10 years time when she retires the last thing we'd want is for it to prevent her from getting benefits like the pension etc.

    Again, very true. I've weighed up most of the foreseeable risks I can think of, which basically includes everything you mentioned above.

    I've drawn to the conclusion that after learning a little more about trusts, should I not come across anything overly negative about them then a trust might be the way to go.

    However finding out about this Land Tax has most definitely given me something to think about and consider.

    Well essentially I would be investing on my own here, I was just told that doing it via a Trust can be a very beneficial way of investing.

    The other option would be to just have my mother sign as a guarantor on the loan and whilst this would be a much simpler option, it wouldn't give me the ability to arbitrarily allocate the profit to other people.

    One major long term benefit I can see from having the property in a trust like this is that when the property finally does start making some good money, rather than having it all taxed at 30-38%, the income could be allocated to my mother (who would presumably be retired by then, or at the very least working very little and in the lower 15% bracket). Furthermore if we decide to include my father in the trust as well, part of the income could be allocated to him also, which would again keep the tax at a minimum.

    Short term - the fact that any losses being made wouldn't have to be deducted on my taxable income is also something beneficial to me. I'm looking at also buying another heavily geared investment property in my own name and it would be at the point where the deductions would only be at 15%, which wouldn't exactly be ideal.
     
  7. jrc77

    jrc77 Well-Known Member

    Joined:
    26th May, 2008
    Posts:
    147
    I did it all through my accountant. As you say, it is just a company (of which you would be the director) acts as the trustee.

    Really a question for a mortgage broker - however I doubt you would get higher than 80% if it is the only asset in the trust.

    In NSW that is correct. Note this is based off the land value only (not full value of property). And is a annual cost.


    The trust can be set to have you as the named beneficiary and all of your relatives as non named beneficiaries (so trust deed can include a list of beneficiaries as Sketchy's spouse, parents, siblings, children, grand children, etc). You can also have the option of distributing to a company to which you are a shareholder or director for extra flexibility in the future.

    Regards,

    Jason
     
  8. Sk3tChY

    Sk3tChY Well-Known Member

    Joined:
    4th Aug, 2007
    Posts:
    358
    Location:
    Sydney, NSW
    I gathered as much. How exactly do I find out my land value?

    This seems like quite an unfortunate cost to have to incur annually, but I guess if the tax savings outweigh it, a trust can still be beneficial.

    I see, probably a little advanced for me right now. If I read through that Trust Magic book though I'll hopefully understand it all, but for the moment I'm just trying to grasp a decent concept on how things work and what my best option would be.

    Thus far the only 2 downsides mentioned with regards to a trust have been:

    - Having to pay Land Tax
    - Added accounting costs

    The latter isn't that big an issue, but if the Land Tax was a large amount that would definitely be something to consider.

    I'm taking it this Land Tax would be classed as a deductible expense?
     
  9. jrc77

    jrc77 Well-Known Member

    Joined:
    26th May, 2008
    Posts:
    147
    There is a tool on the NSW Land Tax Online shop to get the land value of your properties for free. You can get the land value of a potential purchase for a small fee (about $13 from memory).

    I believe it is.

    Regards,

    Jason
     
  10. Sk3tChY

    Sk3tChY Well-Known Member

    Joined:
    4th Aug, 2007
    Posts:
    358
    Location:
    Sydney, NSW
    Is this the page you're referring to?

    Btw, big thanks for all the help thus far champ! I appreciate it, you've already enlightened me a lot!
     
  11. jrc77

    jrc77 Well-Known Member

    Joined:
    26th May, 2008
    Posts:
    147
    Yes. I had to get the title reference off my rates notice (and format it correctly) to find my place - the address search didn't work.

    Regards,

    Jason
     
  12. Sk3tChY

    Sk3tChY Well-Known Member

    Joined:
    4th Aug, 2007
    Posts:
    358
    Location:
    Sydney, NSW
    Yeah, I tried using the Street Address option, but nothing came up.

    So would I look at my council rates notice to get my Title Reference?

    I'm looking at them now, there is a property number, I'm guessing this would be the "title reference" ?
     
  13. jrc77

    jrc77 Well-Known Member

    Joined:
    26th May, 2008
    Posts:
    147
    There is a search option via "property number" - I would give that a go using the number off your council rates.

    Jason
     
  14. Sk3tChY

    Sk3tChY Well-Known Member

    Joined:
    4th Aug, 2007
    Posts:
    358
    Location:
    Sydney, NSW
    Excellent, I'll try that! :)

    One last question (at least for the moment):

    Is it easy to add/remove members from a discretionary family trust?

    Does it cost money?

    Is it as simple as filling in the appropriate paperwork to add/remove someone?

    Or is it a costly thing to do or does it even require starting a completely new trust?

    I ask because I'm thinking long term, when I finally get married and have kids I'd like to know that I could add them to the trust. And/or should any members wish to no longer be apart of the trust, I'd like to know they could easily remove themselves.
     
  15. jrc77

    jrc77 Well-Known Member

    Joined:
    26th May, 2008
    Posts:
    147
    It would depend on the wording of the trust deed I would expect. However you shouldn't need to for either of the reasons you listed - my trust deeds have any future children I have as beneficiaries without having there actual names in it (ie. worded as all of Jason's spouse, children, grand children etc).

    Also, there is no downside (that I am aware of!) as being a named beneficiary of the discretionary trust - being named without receiving any distributions doesn't affect you in any way. Hence you don't need to remove a beneficiary from the trust deed - you just get the trustee decide not to distribute to them anymore.

    Regards,

    Jason
     
  16. Terryw

    Terryw Well-Known Member

    Joined:
    9th Jun, 2006
    Posts:
    653
    Location:
    Sydney
    I am a solicitor and former mortgage broker with a keen interest in trusts. I have some comments:

    You would be hard to find a lender who would lend to a trust without any personal guarantees. It would be rare and probably only available to large purchases.

    Lenders generally will want a personal guarantee from the trustees of the trust. Some lenders will want guarantees from any named beneficiary of the trust (adults only). This you want to avoid as you uncle Larry may not even know about your trust and would not want to give a guarantee. So it may be best not to name beneficiaries, but to include them in a class of beneficiaries (eg 'uncles'). But watch out for this restricting the beneficiaries somewhat – eg if you named uncle Larry his wife may be a beneficiaries, but if you haven't named him she may not fall into your definition.

    If a company is trustee then the lender will want guarantees from all directors and possibly shareholders too (if different).

    Watch out for serviceability long term. Guaranteeing loans when it may not be necessary may mean you will be restricted in future borrowings. It also adds risk. Eg you have a trust with a non working spouse and both guarantee the loan. Your non working spouse adds no value in terms of borrowing more so leave him/her off.

    Generally trusts can borrow high LVRs like individuals however with a corporate trustee this may be restricted a bit.

    Land tax is a major worry. But after you have reached the threshold you will be paying land tax anyway as an individual so it may not be such an issue.

    Watch out for relatives on Centrelink benefits as being a beneficiary of a trust could mean the trust assets are treated as their own for assessment purposes and benefits could be lost.

    Tax is an important benefit. An adult can now earn up to $16,000 pa without paying tax because of the low income tax rebate.

    Trust assets do not form part of your estate at death (generally), so this can have advantages and disadvantages too.

    Trust assets also do not form part of your estate on bankruptcy (generally) – whether as trustee or as a beneficiary. So asset protection is the other major advantage.


    Adding someone to a discretionary trust – if you mean as a beneficiary – is complex. If you are adding someone who is not already a beneficiary by falling into one of the classes listed then you will need to be very careful as it can trigger a resettlement. A resettlement is when it is deemed that the trust as changed and a new trust formed – with all the assets of the old trust being transferred to the new one. This has CGT and stamp duty implications, big implications.
     
  17. Sk3tChY

    Sk3tChY Well-Known Member

    Joined:
    4th Aug, 2007
    Posts:
    358
    Location:
    Sydney, NSW
    Right, got it. I guess I'd discuss that further with the accountant when/if I decide to go with a trust. Seeing as it's a discretionary "family" trust I'd assume only family members could be apart of it, so something like:

    - Parents
    - Spouse
    - Children
    - Grandchildren

    Should cover all bases.

    Excellent. My only thought was that if you're of a member of a trust that owned $X amount of dollars in assets, they may be counted as your own personal equity and thus prevent you from certain government benefits.

    For example if I bought $500,000 worth of property in the trust and had my mother as a beneficiary, when she retired she wouldn't be eligible for the pension because that $500,000 worth of property would be classed as something she owned.

    Again, prob something I'd double check with the accountant, but from what I'm gathering assets in a trust aren't added to assets owned by an individual.

    Well given the trust wouldn't really have any other assets or income other than the property and its rental return, I can understand why.

    Thanks for that. I'm guessing it's probably better to put people into classes rather than naming them individually, it would make things simpler. And as Jason pointed out above, it means you don't have to change things as much.

    Well right now I'd imagine I'd set it up with me personally being the Trustee, although I may consider using a company if it has some benefits that would apply to me.

    Yup, understandable. If I guarantor a loan for a trust it will essentially be like having the loan in my own name, thus restrict my borrowing power.

    Well provided they have an Individual guarantoring the loan, I'd imagine they wouldn't have a problem with offering identical LVRs.

    Indeed, this is my biggest concern thus far with opening up a trust. As an individual I'm still well short of the land tax threshold.

    This was also a big concern of mine, but as Jason pointed out above; being named as beneficiary shouldn't affect you in anyway unless you're actually receiving distributions.

    From what I've managed to gather the assets owned by a trust aren't at all linked to assets owned by individuals. So even if the trust owned $10mil worth of assets and my mother was a beneficiary, she'd still only be classed as owning just her own home.

    Tax is the biggest benefit! And wow I wasn't aware it was $16,000! I thought it was just $6000.

    Not entirely sure what you mean here mate?

    I've gathered this much. I don't think it would be that big a benefit to me because I don't exactly plan on going bankrupt any time soon, but I guess it's nice to know the assets are protected. :p


    Adding someone to a discretionary trust – if you mean as a beneficiary – is complex. If you are adding someone who is not already a beneficiary by falling into one of the classes listed then you will need to be very careful as it can trigger a resettlement. A resettlement is when it is deemed that the trust as changed and a new trust formed – with all the assets of the old trust being transferred to the new one. This has CGT and stamp duty implications, big implications.[/QUOTE]
     
  18. Terryw

    Terryw Well-Known Member

    Joined:
    9th Jun, 2006
    Posts:
    653
    Location:
    Sydney
    [/QUOTE]

    Not with centrelink. Your mother would likely be assessed on the basis that the assets in the trust would her own.

    see Part 3.18 of the Social Security Act
    SOCIAL SECURITY ACT 1991

    and this information on the Centrelink site:
    Trusts and private companies
     
  19. Terryw

    Terryw Well-Known Member

    Joined:
    9th Jun, 2006
    Posts:
    653
    Location:
    Sydney
    You cannot leave assets of the trust in your will.
     
  20. Sk3tChY

    Sk3tChY Well-Known Member

    Joined:
    4th Aug, 2007
    Posts:
    358
    Location:
    Sydney, NSW
    Well the first link makes absolutely no sense to me, but the second one definitely does, thanks for that information.

    It's weird how they say "may" though, I'm guessing there may be circumstances where they don't take the trust assets into consideration.

    Perhaps in the event where the beneficiary made no income from them?

    Right, got it. I'm guessing that perhaps you would have somewhere in the trust deed who would become the trustee in the event of your death?

    Mmmm, there's so many bits and pieces to this whole trust thing that need to be considered, it's all a bit complicated.

    My investment strategy has changed now anyway to where I'm looking at just buying 1 more property in the near future, so I may just get the next one in my own name as an individual for the moment to keep things simple.