All Topics / Legal & Accounting / Family Trust Confusion

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  • Profile photo of Luke DLuke D
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    @luke-d
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    I plan to buy my first investment property in the next couple of months and I have a family trust (company as trustee) set up to do so. I was recently told that when I decide to buy my PPOR I should get the loan in my name and then loan the money back to the trust and I can claim the interest payments on the loan in my name. Is this entirely true? How does it work?

    How does this work if you are paying market rent for the property and whether it was negative or positively geared? I don't have a problem with CGT exemptions as I would want to live in this place for a long time and have no plans on selling but instead keeping it as an "investment property"?

    Profile photo of TerrywTerryw
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    @terryw
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    Hi Luke

    You have had some bad advice there.

    Bad on 2 accounts:

    1) loans
    If your trust is going to be the owner of the property, then it is the trustee's name on title. ie Your company will be the legal owner. So to get the loan in your name would mean the bank would need to lend the money to a third party. This may have been achieveable with some banks in the past, if you were the director of the company, but it is extremely difficult now.

    2). Tax
    You say you have a family trust. I assume this is a discretionary trust. If you were able to borrow the money in your name, you then have to overcome the hurdle of making the loan deductible. If you were to lend the money to the trust you would be charged interest, and you should charge your trust interest as well, at commercial rates too. But the interest received would cancel out the interest paid. net result is nil.

    Another hurdle is that if your trust is discretionary, then there is no guarantee that you will get any distributions. The trustee has absolute discretion. So if you were able to lend your money to the trust with the trust not paying you any interest, you would have no grounds to claim the interest as there is no guarantee of any return on the money invested – ie it is commercially unviable.

    If later on you have built up some equity in your PPOR and you get a LOC and onlend it to the trust (eg for the trust to use as deposits) then this is ok. the trust would pay you interest (income) and you would claim the interest you are charged. so net result is the trust claims the interest.

    Maybe you were thinking about unit trusts.
    With unit trusts each unit hold has a fixed entitlement, so it is possible to borrow to buy units in the unit trust, but still difficult to get a loan for this. It is also possible to tax deduct the interest on funds borrowed to buy units, but it has to be set up correctly.
    If you had a unit trust, then you

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
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    Profile photo of Luke DLuke D
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    @luke-d
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    Hi Terry,
    thanks for the quick reply. I am going to have to find out exactly what he meant when I was told this. I will let you know.

    Profile photo of Investors ZorbaInvestors Zorba
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    Luke get advice from Chan & naylor re their Property Investment Trust(PIT) specifically designerd for property investment and nothing else.

    Profile photo of KoozKooz
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    @kooz
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    Hi Luke,

    I just came back from a visit with my accountant and Bingo! I asked the same question as you and received the same answer as what Terry gave.

    So I reckon Terry is dead on!

    Kooz

    Profile photo of TerrywTerryw
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    @terryw
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    It can be done with the unit trust, you can borrow to buy the units and personally claim the interest, but this leaves things very similar to buying in your own name anyway.

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    http://www.Structuring.com.au
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    Lawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au

    Profile photo of Luke DLuke D
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    I finally got some of the answers I needed on my original topic. I don't think it helps me much as it clarifies more what you first wrote Terry. I got told that you borrow the money in your name, loan it to the trust charging a commercial rate of interest.

    Is it possible to charge your trust more interest then the bank charges you to claim any negative gearing?

    Luke

    Profile photo of TerrywTerryw
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    @terryw
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    If may be difficult to borrow the money in your own name unless you use your own property as security. It is difficult to borrow in your name if the company is the owner as this will be 3rd party lending.

    But, assuming you can, and you charge your trust more than you are paying, then you will be making a profit and diverting money out of the trust into your personal income. So you pay more tax

    If you charge your trust less, then you probably cannot justify the claiming of interest as it is not commercial – you are making a loss. And if your trust is a discretionary trust there is no guarantee you will get any return from the trust in the form of a distribution so you probably could not claim the interest at all. This is the problem with claiming interest under hybrid trusts.

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    http://www.Structuring.com.au
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    Lawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au

    Profile photo of eddieceddiec
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    @eddiec
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    Terryw wrote:
    If may be difficult to borrow the money in your own name unless you use your own property as security. It is difficult to borrow in your name if the company is the owner as this will be 3rd party lending.

    But, assuming you can, and you charge your trust more than you are paying, then you will be making a profit and diverting money out of the trust into your personal income. So you pay more tax

    If you charge your trust less, then you probably cannot justify the claiming of interest as it is not commercial – you are making a loss. And if your trust is a discretionary trust there is no guarantee you will get any return from the trust in the form of a distribution so you probably could not claim the interest at all. This is the problem with claiming interest under hybrid trusts.

    Agreed with most of this, Terry. However, my view is that you can on-lend money to a discretionary trust and get a tax-deduction for the interest on the loan you drew down from the bank in the first instance, provided that the trust pays you interest on the on-lent funds.  The nexus that gives rise to the deduction in your hands, in this circumstance, is the derivation of interest income by you on-lending the funds you obtained from the bank to the trust.  This is in contrast to the situation where you borrow to buy units (fixed entitlement) in a unit trust, which is one of the issues with certain hybrid trusts.

    I do agree that third party borrowing is harder these days.  Having said that, my bank did that for me recently without too much hassles.  If the issue is the corporate trustee, perhaps use an individual trustee who is also the borrower. 

    Also agree with you that there is no point charging more interest to the trust because the amount by which the interest paid by the trust to you exceeds the interest payable by you to the bank will only give rise to tax in your hands.

    Incidentally, there is no point negative gearing in a trust unless the trust derives other income.  Otherwise, the net loss is trapped within the trust until the trust derives income in future, if any, to recoup the carried forward tax losses.

    Eddie
    [email protected]

    Profile photo of ajaydee73ajaydee73
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    The only way you will get a tax benefit from this situation is if the trust is earning other income which it can deduct the interest from. The trust will then receive the tax benefit.

    Profile photo of Luke DLuke D
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    @luke-d
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    What is the law when it comes to negative gearing and trusts? Can someone give a definitive answer because some say you can and others say you can’t. Does that mean accountants like chan and naylor with their property investors trust are technically not right or is it the accountants who tell you it’s not allowed just not creative enough?

    I don’t intend on purchasing investment properties to negative gear them but if they happen to be in that situation the tax benefits would help out. I don’t want to have to offset other income I earn from my share trading trust because I might not be able to use these profits to purchase more property. I would only be breaking even or a little bit in front.

    If someone knows the right answer I’d love to hear it because all the “top reccommended” accountants all say different stuff which also makes it harder to decide who you want looking after your finances.

    Profile photo of TerrywTerryw
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    @terryw
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    eddiec wrote:
    Terryw wrote:
    If may be difficult to borrow the money in your own name unless you use your own property as security. It is difficult to borrow in your name if the company is the owner as this will be 3rd party lending.

    But, assuming you can, and you charge your trust more than you are paying, then you will be making a profit and diverting money out of the trust into your personal income. So you pay more tax

    If you charge your trust less, then you probably cannot justify the claiming of interest as it is not commercial – you are making a loss. And if your trust is a discretionary trust there is no guarantee you will get any return from the trust in the form of a distribution so you probably could not claim the interest at all. This is the problem with claiming interest under hybrid trusts.

    Agreed with most of this, Terry. However, my view is that you can on-lend money to a discretionary trust and get a tax-deduction for the interest on the loan you drew down from the bank in the first instance, provided that the trust pays you interest on the on-lent funds.  The nexus that gives rise to the deduction in your hands, in this circumstance, is the derivation of interest income by you on-lending the funds you obtained from the bank to the trust.  This is in contrast to the situation where you borrow to buy units (fixed entitlement) in a unit trust, which is one of the issues with certain hybrid trusts.

    I do agree that third party borrowing is harder these days.  Having said that, my bank did that for me recently without too much hassles.  If the issue is the corporate trustee, perhaps use an individual trustee who is also the borrower. 

    Also agree with you that there is no point charging more interest to the trust because the amount by which the interest paid by the trust to you exceeds the interest payable by you to the bank will only give rise to tax in your hands.

    Incidentally, there is no point negative gearing in a trust unless the trust derives other income.  Otherwise, the net loss is trapped within the trust until the trust derives income in future, if any, to recoup the carried forward tax losses.

    Eddie
    [email protected]

    Hi Eddie

    Thanks for that. I agree, but ….

    If the trust borrows money from an individual the trust would pay interest and the individual will need to declare this as income. So the net result for the individual is + – = 0 and it is the trust that gets the deductions of interest. This is assuming the interest rate is the same for the person borrowing from the bank and the amount charged to the trust.

    If the individual was to borrow at, say, 5% and lend to  the trust at 2% the individual will make a 3% loss and this could enable the individual to lose income and reduce tax. But to be able to claim a loss there must be a commercial prospect of obtaining a profit. With a discretionary trust there is no guarantee any one beneficiary would get a distribution (because it is at the trustee's discretion) so the situation is not commercial and the ATO wouldn't allow the deductions.

    What do you think?

    Thanks

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    http://www.Structuring.com.au
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    Lawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au

    Profile photo of TerrywTerryw
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    Luke D wrote:
    What is the law when it comes to negative gearing and trusts? Can someone give a definitive answer because some say you can and others say you can't. Does that mean accountants like chan and naylor with their property investors trust are technically not right or is it the accountants who tell you it's not allowed just not creative enough? I don't intend on purchasing investment properties to negative gear them but if they happen to be in that situation the tax benefits would help out. I don't want to have to offset other income I earn from my share trading trust because I might not be able to use these profits to purchase more property. I would only be breaking even or a little bit in front. If someone knows the right answer I'd love to hear it because all the "top reccommended" accountants all say different stuff which also makes it harder to decide who you want looking after your finances.

    Hi Luke

    I think the law is very clear on this. Trusts are separate entities for taxation purposes and therefore if a trust incurs a loss it cannot be used to offset income of another entity such as  you. eg. If you make a profit and your wife makes a loss they cannot cancel each out.

    Some were of the view that certain trusts can enable negative gearing. But this was achieved in a round about way and worked like this:

    Trust buys a property and units are issued.
    Person A borrows to buy the units of the trust.
    The unit holder received an income from the trust
    If the income is less than the interest the loss can be used to offset other income of person A

    So the trust is not negative gearing, it is the person buy units in the trust.

    Hybrid and unit trusts are still able to do this. But the wording of the deed is very important in determining tax deductibility. See the recent Tax Determination from the ATO: TD  2009/17

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    http://www.Structuring.com.au
    Email Me

    Lawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au

    Profile photo of eddieceddiec
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    @eddiec
    Join Date: 2004
    Post Count: 113
    Terryw wrote:
    eddiec wrote:
    Terryw wrote:
    If may be difficult to borrow the money in your own name unless you use your own property as security. It is difficult to borrow in your name if the company is the owner as this will be 3rd party lending.

    But, assuming you can, and you charge your trust more than you are paying, then you will be making a profit and diverting money out of the trust into your personal income. So you pay more tax

    If you charge your trust less, then you probably cannot justify the claiming of interest as it is not commercial – you are making a loss. And if your trust is a discretionary trust there is no guarantee you will get any return from the trust in the form of a distribution so you probably could not claim the interest at all. This is the problem with claiming interest under hybrid trusts.

    Agreed with most of this, Terry. However, my view is that you can on-lend money to a discretionary trust and get a tax-deduction for the interest on the loan you drew down from the bank in the first instance, provided that the trust pays you interest on the on-lent funds.  The nexus that gives rise to the deduction in your hands, in this circumstance, is the derivation of interest income by you on-lending the funds you obtained from the bank to the trust.  This is in contrast to the situation where you borrow to buy units (fixed entitlement) in a unit trust, which is one of the issues with certain hybrid trusts.

    I do agree that third party borrowing is harder these days.  Having said that, my bank did that for me recently without too much hassles.  If the issue is the corporate trustee, perhaps use an individual trustee who is also the borrower. 

    Also agree with you that there is no point charging more interest to the trust because the amount by which the interest paid by the trust to you exceeds the interest payable by you to the bank will only give rise to tax in your hands.

    Incidentally, there is no point negative gearing in a trust unless the trust derives other income.  Otherwise, the net loss is trapped within the trust until the trust derives income in future, if any, to recoup the carried forward tax losses.

    Eddie
    [email protected]

    Hi Eddie

    Thanks for that. I agree, but ….

    If the trust borrows money from an individual the trust would pay interest and the individual will need to declare this as income. So the net result for the individual is + – = 0 and it is the trust that gets the deductions of interest. This is assuming the interest rate is the same for the person borrowing from the bank and the amount charged to the trust.

    If the individual was to borrow at, say, 5% and lend to  the trust at 2% the individual will make a 3% loss and this could enable the individual to lose income and reduce tax. But to be able to claim a loss there must be a commercial prospect of obtaining a profit. With a discretionary trust there is no guarantee any one beneficiary would get a distribution (because it is at the trustee's discretion) so the situation is not commercial and the ATO wouldn't allow the deductions.

    What do you think?

    Thanks

    Agreed, Terry, although in practice, we will always on-charge the interest at exactly the same rate. 

    If the individual intentionally creates a loss by way of differential interest rates as you described, the interest attributable to the interest rate difference will be taken to have a non-income producing purpose (the purpose is to obtain a tax benefit), which will not be tax-deductible.  In other words, I think we agree on the outcome, albeit we got there via different ways. :)

    Eddie
    [email protected]

    Profile photo of TerrywTerryw
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    @terryw
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    Excellent.

    Thanks Eddie

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    http://www.Structuring.com.au
    Email Me

    Lawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au

    Profile photo of Susannah BowdenSusannah Bowden
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    @susannah-bowden
    Join Date: 2006
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    Sideways to the original question: I have set up a family trust with a company as corporate trustee and now wish to put a positive gear property into the trust. The conveyancer says that a trust cannot be registered as an owner on a title. A trustee is registered on the title. But if the company is the title and Steve suggests not to put a property into a company how does this work? Confused

    Profile photo of Dan42Dan42
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    Susannah Bowden wrote:
    Sideways to the original question: I have set up a family trust with a company as corporate trustee and now wish to put a positive gear property into the trust. The conveyancer says that a trust cannot be registered as an owner on a title. A trustee is registered on the title. But if the company is the title and Steve suggests not to put a property into a company how does this work? Confused

    Hi Susannah,

    The company name goes on the title. This is because a company is a legal entity, whereas a trust is not. However the company is solely acting as trustee, so the trust is the operating entity, or beneficial owner of the property.

    In other words, the property is owned for tax purposes by the trust, not the company, as the company is acting solely as trustee of the trust, not in its own right.

    I hope I haven't confused you further!

    Profile photo of Susannah BowdenSusannah Bowden
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    @susannah-bowden
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    Post Count: 8

    Thanks for that. Now an overly simplistic query in regards to trusts –
    I have set up “X Investments Pty Ltd” as the Corporate Trustee for “ABC Family Trust” in SA. Here are the questions:

    1. Which name does the bank account get opened in/which name doess the borrowing?
    2. Which name goes on the purchase contract/title deed for the property?
    3. Which name do the receipts for rental income, as well as losses (e.g. buyers agent fees, renovation costs etc.) go in ?
    4.Which one does the tax return?
    5.Does anyone know of any good trust user guides where all of these nuts & bolts details are spelt out in black & white?
    Cheers,
    Susannah of SA

    Profile photo of TerrywTerryw
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    @terryw
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    Susannah Bowden wrote:
    Thanks for that. Now an overly simplistic query in regards to trusts – I have set up "X Investments Pty Ltd" as the Corporate Trustee for "ABC Family Trust" in SA. Here are the questions: 1. Which name does the bank account get opened in/which name doess the borrowing? 2. Which name goes on the purchase contract/title deed for the property? 3. Which name do the receipts for rental income, as well as losses (e.g. buyers agent fees, renovation costs etc.) go in ? 4.Which one does the tax return? 5.Does anyone know of any good trust user guides where all of these nuts & bolts details are spelt out in black & white? Cheers, Susannah of SA

    its hard to get your head around initially. Just think of the trustee as the owner of the property. So all trust property goes in the trustee's name. This includes bank accounts, title deeds etc. On some things, such as bank accounts, but not on land titles, you can also record that the trustee is acting in their capacity as trustee – but this is optional.

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    http://www.Structuring.com.au
    Email Me

    Lawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au

    Profile photo of No1No1
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    @no1
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    Susannah,

    When X Investments p/l goes to the bank it has two options.

    Option one is to set up an account in the name of ‘X Investments P/L’
    Option two is to set up an account in the name of ‘X Investments P/L’ as trustee for ‘The ABC Family Trust’

    It is important to note ( as others have) a trust is not a legal entity. It is only a structure. It requires a legal entity to enter in to transactions on it’s behalf (the trustee) and legal entities to send its income to so tax can be paid (beneficiaries).

    Terry mentions a trust is an entity for tax purposes, meaning it has it’s own tax return – not to be mistaken as a legal entity like a person or company.

    Therefore answers to your questions;

    1. Bank accounts and lending should be X Inv. P/L as trustee for the ABC trust
    2 + 3. Contract and invoicing can be in the company only, or company as trustee (I would include the trust) – make sure you use the trusts ABN if it has one. Only the company name will be on the title and transfer ( as the trust is not a legal entity).
    4. The trust has its own tax return. If there is a profit there will be a section at the end outlining which beneficiaries received those profits and how much they received. It will then appear in the beneficiaries tax returns as income.
    5. A book? I don’t know of one. Trusts are very simple. If you get the basics right you will understand them – you will still need an accountant for the tax side.

    Important.

    The trustee can also own asset in it’s own right, or carry on business outside of the trust. If it runs a business out side of the trust it will have it’s own ABN. The best way to know if a company is acting on behalf on a trust is to google “ABN look up” and enter the ABN. This will tell you if the A.B.N is linked to company or trust.

    This is why it is important to have bank accounts and lending with company as trustee for trust. Otherwise without have the trust listed on contract or title someone could argue funds are not in the trust but rather owned by the trustee…

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