Sunday, 13 October 2013

Holding a Rental Property in a Trust

Holding a Rental Property in a Trust
BAN TACS Accountants Pty Ltd Newsflash

If you are concerned about land tax, depending on which state you are in, a trust might give you another land tax threshold. 

For example in Queensland a trust does not pay land tax until the unimproved land held by the trust in the state of Queensland exceeds $350,000. 

NSW gets complicated but certainly discretionary trusts are not entitled to a threshold at all so will pay land tax on any property they own 

NT has no land tax. 

Victoria only gives trusts a $25,000 threshold. Another way of avoiding land tax is to buy properties in different states.

Here is a bit of a run down on the two types of trusts you are likely to considers:
Fixed/Unit Trusts:
Generally you would borrow money to purchase units in the trust. This would give you a fixed right to the income of the trust which then gives you a right to deduct the interest on the loan in your personal tax return. The trust may also borrow but because of your contribution the trust makes a profit which is
distributed to you and appears in your tax return so that the interest on your loan is a cost of earning income. If the property is overall negatively geared then your interest will exceed the income you receive from the trust.
This may sound good but all it really provides is protection of your personal assets from anyone suing the trust. If anyone is suing you they would gain access to the trust by gaining access to the units you own; so only a little better asset protection than owning in your own name. The tax outcome is about the same just an extra tax return. There is a stamp duty advantage in that once the property is held in the trust you could transfer the units (for market value) amongst family members without paying stamp duty on the transfer but it would trigger CGT, so you are unlikely to do this.
Discretionary Trusts:
A discretionary trust allows you to decide each year who gets the profits and/or capital gain because unlike a unit trust there is no fixed right to profit. The down side of no fixed right to profit is that you cannot effectively negatively gear in your personal tax return. You have no fixed right to profit so the interest on the money you borrow to put into the discretionary trust is not a cost of earning trust income. To make it deductible (a cost of earning income) you need to charge the trust interest at the same or a higher rate. This means the deduction effectively moves into the trust and is locked in there until it makes a profit as trusts cannot distribute losses. The up side of no fixed right to profit is that if you are sued, your creditors cannot demand that the trust pays them anything. If the property is positively geared anyway then the discretionary trust has no down side and putting a positive property into a discretionary trust gives you something to offset against other rental property losses so you may then be able to afford to hold a negatively geared property in a discretionary trust.

Warning Any trust that claims to give you the benefits of a combination of those above risks being treated by the ATO as a discretionary trust removing your right to claim the interest on the money used to buy the units; or requires the trust to buy back the units which will trigger a CGT event at market value to the unit holders.

Note Trusts are sometimes marketed as a succession planning tool. A trust can only operate for 80 years, at the end of which the assets must be transferred to the beneficiaries and the trust has to pay CGT. Accordingly, if you must use a trust at all, to control from the grave, it is better to create it in your will so it lasts as long as possible and the tax benefits of distributing income to minors are much better. If you hold a property in your own name you can transfer it to your heirs through your will with no CGT consequences and they can do the same. Keeping a property in the family through personal ownership and wills will completely avoid CGT for an infinite period until someone sells the property.