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Negative gearing with Managed Fund through Hybrid Trust

Discussion in 'Investing Strategies' started by Maverick, 2nd Feb, 2006.

  1. Maverick

    Maverick Well-Known Member

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    Melbourne
    Hello,

    I'm wondering whether negative gearing can be utilised by investing into Managed Fund (by margin lending) through Hybrid Trust (HDT).

    Case: Family (1 high income earner and 1 low income earner) with HDT (originally established to invest into property) has some savings (after purchasing IP) to invest.

    I can see how it works with investments property where there are other expenses on top of interest bill and distribution to income units holder at the end of year is after the property expenses are taken out.

    But with no other expenses except (margin loan) interest, wouldn't the entire Managed Fund distribution go to the units holder? And if the distribution is greater than interest bill, the additional income is even getting taxed :confused:

    Wouldn't it be just easier to give (gift) money to the trust and let the trust borrow through margin lending and distribute the profit to lower income earner beneficiary of the trust?

    Thank you.
     
  2. Nigel Ward

    Nigel Ward Team InvestEd

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    Hi Mav

    One way to do it is:

    1) high income earner borrows against a property (eg by using a line of credit against say the family home or one or more IPs if in own name)

    2) use those borrowings to buy units in HDT let's call it $100k to make my mental arithmetic easier :rolleyes:

    3) trustee then uses that $100k as the "deposit" for their margin loan.

    4) Margin loan (in trustee's name) is obtained

    5) draw down on margin loan $100k add that to the $100k proceeds from the unit subscription

    6) trustee through margin lender applies for $200k worth of units in the Managed Fund

    7) Margin Loan LVR = 50%

    8) Assume the managed fund returns 10% income i.e. $20k

    9) Less Margin loan interest of say $8k

    10) The trust must distribute all its net trust income or face tax on it at top marginal rate. Thus $12k must be distributed (I'm simplifying here there may be many other trust expenses which reduce this amount)

    10) Entitlement of high income earner under the terms of income units will in all likelihood be calculated by reference to a formula which basically means that they get 50% of the net income generated from the investment the unit proceeds were used to acquire. SO... $6k distribution to high income earner

    11) High income earner paid say $7k in interest on his or her real property secured line of credit and receives $6k in distributions therefore $1k negatively geared (i.e. save $485 tax) but $6k in the hand

    12) low income earner gets, after exercise of the trustee's discretion a distribution of $6k. Which, assuming no other income will be tax free.

    If the $100k was borrowed and just gifted then the interest on it would not be deductible.

    If you don't have home or IPs with spare equity to borrow against to provide seed funds by way of subscription for units then you may be able to convince your margin lender to let you borrow and have the trustee of your trust guarantee the loan and provide third party charge security. Not sure if anyone has managed to organise that with their lender. Nick/Steve?
     
  3. Maverick

    Maverick Well-Known Member

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    Hi Nigel,

    Thank you very much for the very detailed reply.

    I'm not looking for the financial advice and I understand that the opinions expressed on this forum constitute a general comment.

    With the above disclaimer, I would be interested to know what can specifically be done in the following situation:

    - it is not possible to borrow against the investment property at this stage (not enough equity yet)
    - there are some savings left after purchasing IP
    - although the savings may be sufficient for another deposit on IP, the serviceability is the problem – bank won’t lend any more as the maximum (to the limit of serviceability) was borrowed to by the IP

    So the idea was to invest savings into managed fund until the serviceability is improved.
    And I was looking for the most effective way (also tax effective) to invest considering high income earner + low income earner + Hybrid Trust situation.

    All comments are very welcomed.

    Regards.
     
  4. Nigel Ward

    Nigel Ward Team InvestEd

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    I suppose the simple and expedient solution is to just invest the cash into the managed fund solely in the low income earner's name. Some of the banks will then include those distributions in your income for servicability purposes after a certain time.

    Remember, because it's cash, it's easy to move between you both before investment.

    You should of course speak to your financial adviser and accountant about the implications of any investment and your long term goals.

    N.
     
  5. Glebe

    Glebe Well-Known Member

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    Hi Maverick,

    I use a HDT and margin loan into managed funds. This is what occured:

    Note: wife high income earner, myself middle income earner, a relative of ours is low income earner.

    1. Wife and I gifted $305 000 to our HDT.

    2. Wife took out margin loan with Leveraged Equities to the tune of $355 000. With the $355 000 she bought 355 000 special income units in the trust, and the trust used $355 000 + $305 000 = $660 000 to invest in a portfolio of managed funds.

    3. Come tax time, wife's interest cost of $28 000 is tax deductible.

    4. Come tax time, income generated by the trust is distributed. A ratio of 355/660 (ie 54%) of the income is distributed to wife. The remainder (46%) of the income is distributed to our relative who is a low income earner.
     
  6. jscott

    jscott Well-Known Member

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    When doing this sort of thing... i.e. buying shares in a HDT etc. do you have to know all the details upfront, or is it simply at tax time where the accountant writes up who bought what units in the trust and whether you gifted money or lent it to the trust, etc. etc. ?
     
  7. Maverick

    Maverick Well-Known Member

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    Nigel, so if the intention is to distribute any possible income to low income earner anyway even if the investment is done through the trust, you wouldn't even bother doing it through the trust?
    I can see some pro's and con's to invest through the trust:
    PRO'S:
    - asset protection
    - flexibility with distributions should the circumstances change
    CON'S:
    - potentially higher/additional costs for trust

    Regards.
     
  8. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    One of the most important pieces of advice I was given very early in my investing career was to "begin with the end in mind". That is - don't make decisions about structuring and strategy based on my immediate goals, make them with consideration of where I want to be in 5 years, 10 years, 20 years time.

    It can cost a LOT more to restructure your assets in the future WHEN your situation changes than it will cost to maintain good structures up front.

    I understand that a few thousand dollars a year in extra holding costs can make the difference between affording and not affording another investment, but at some point, if you plan on owning a lot of assets, you need to get your structures right, and it is better to do this upfront - which will save you a lot of money in the longer term.

    So my suggestion to you, Maverick, is to visualise yourself and your investment portfolio in the future once you have a significant value of assets. Will you want a trust then ?

    If you only ever plan on buying a couple of IPs and some shares/funds - then it's probably overkill. But if you are thinking 5+ IPs would be nice, as well as a multi-million dollar share/fund portfolio (or more!), then you need to seriously think about what structures you'll need in place to manage this portfolio when you get there.
     
  9. Nigel Ward

    Nigel Ward Team InvestEd

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    Mav

    To put my comment in context, you suggested the money was going to be used for a property deposit and I got the impression (perhaps incorrectly) that you're not flush with cash at the moment.

    On that basis it would be cheaper and the most tax efficient option NOW to do as I suggested, particularly if you'll be withdrawing the funds in a reasonably shortish timeframe (no doubt you'll heed all the warnings about investing timeframes etc etc).

    It is always worth considering structuring. I'm a huge advocate for it, set it up early definitely, but given the choice between setting your structure and having no money to invest and investing (with the thought in mind that you'll set up the structure soon and where we're talking about shares/funds rather than property) then I'd choose investing first and learn about structures for next time.

    But perhaps I have read too much into your post. :rolleyes:

    N
     
  10. Maverick

    Maverick Well-Known Member

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    If what Nigel suggested was possible, i.e. Trust's $100,000 worth of existing managed funds could be used as a security and individual would get a margin loan of $100,000 (50% gearing) and buy income producing units in Hybrid Trust, which would make Trust's capital of $200,000 (existing $100,000 + $100,000 from units subscription), COULD THEN TRUST GET ANOTHER MARGIN LOAN (e.g. $200,000 for 50% gearing) AND INVEST A TOTAL OF $400,000?????
    I do not think that would be possible because THE SAME ORIGINAL FUNDS WOULD BE USED AS A SECURITY TWICE :confused:

    Some help will be highly appreciated here...
     
  11. Nigel Ward

    Nigel Ward Team InvestEd

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    That's right, you couldn't use the same assets as security for two loans without disclosing that to financiers (and thus they wouldn't accept it)...but as I mentioned, you could buy your income units with a loan secured against your IPs and then your Trustee could get the margin loan using the shares/managed fund units bought by the trustee with the proceeds of unit subscription...so it's effectively borrowing against assets bought with borrowed money - double gearing... makes your cash on cash return infinite because it's all borrowed money. If you get the arbitrage right (i.e. the difference between returns and weighted average interest cost) then it's basically making money out of nothing... or to look at it another way you're working your equity twice as hard...

    WARNING WARNING DANGER WILL ROBINSON :D please don't try this at home without getting financial advice.

    Cheers
    N.