Forums / Property Investing / Help Needed! / Set up a Family Trust or not?

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  • Profile photo of dreamteamdreamteam
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    @dreamteam
    Join Date: 2010
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    I'm re-reading chapter 9 of Steve McKnight's first book '0-130 properties in 3.5 years' about structuring prior to purchasing investment property.  To set up a Family Trust as the most advantageous structure seems a no-brainer on reading this chapter.

    However.

    p. 175 says that if I already have significant debt it is of little use.  Yes, that would be me:

    I own one PPoR (own name) and one IP (tenant in common with partner).

    Combined income including IP income: around $130,000
    Debt: $600,000
    Equity: $600,000

    Furthermore, aside from the $1500 or so set-up costs plus $1000 p.a. ongoing costs to administer, my accountant also pointed out that if I purchase IP's using a Family Trust then there is no land-tax exempt threshold as there is with ownership as an individual.  This means that if I buy a property I have to pay land tax ragardless of it's unimproved land value if I buy it through a Trust but as an individual I don't pay land tax until a certain threshold is reached (at around $350,000 unimproved land value).

    So what route should I take?  Family Trust or individual?

    Profile photo of JJ7JJ7
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    @jj7
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    You could read up some more on what different trust structures deliver in terms of advantages and also additional costs (http://www.trustmagic.com.au/ is great for this – very small investment for a whole lot of information – there are plenty of ideas in there on how to leverage trust structures harder than what you generally hear about and if you pull your credit card out you could be reading about them pretty well straight away as you can download it as an ebook).

    You could crunch the numbers based on the knowledge you gain from your research and look at the decision from a purely financial perspective ignoring risk etc.

    Finally, you could & should find an accountant and/or lawyer knowledgeable in these structures and pay for some professional advice as there are lots of variables, including your personal risk appetite, the risks you run in your employment, family situation etc, etc which go into making this kind of decision. For example, if you water plants at a nursery for a living then your risk of being sued for professional negligence is probably a lot lower than if you are an accountant providing trust structure advice to a property investor, so the value of using trusts for risk management is correspondingly lower. Professional advice is cheap compared with what you can blow if you get it wrong, so don’t skimp. I’d pay $500/hr for the best every time over $300/hr for an also ran – just the $1000-$1500pa running costs of a trust make 45mins advice a bargain.

    Before you take advice from a professional try to educate yourself to the level that you know what you are asking them and why.

    Profile photo of TerrywTerryw
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    @terryw
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    dreamteam wrote:
    I'm re-reading chapter 9 of Steve McKnight's first book '0-130 properties in 3.5 years' about structuring prior to purchasing investment property.  To set up a Family Trust as the most advantageous structure seems a no-brainer on reading this chapter.

    However.

    p. 175 says that if I already have significant debt it is of little use.  Yes, that would be me:

    I own one PPoR (own name) and one IP (tenant in common with partner).

    Combined income including IP income: around $130,000
    Debt: $600,000
    Equity: $600,000

    Furthermore, aside from the $1500 or so set-up costs plus $1000 p.a. ongoing costs to administer, my accountant also pointed out that if I purchase IP's using a Family Trust then there is no land-tax exempt threshold as there is with ownership as an individual.  This means that if I buy a property I have to pay land tax ragardless of it's unimproved land value if I buy it through a Trust but as an individual I don't pay land tax until a certain threshold is reached (at around $350,000 unimproved land value).

    So what route should I take?  Family Trust or individual?

    That sounds strange and incorrect even – re existing?debt levels. Existing debt levels shouldn:t have any bearing on future purchases using a trust.

    $1000 pa to run sounds expensive too.

    Also did you accountant tell you that any losses are trapped in the trust and you cannot offset them against your personal income? This and the land tax are what usually makes it not worthwhile for most people.

    Whether it is worth it for you or not – you should make a spreadsheet and do some calcs both buying in a trust and in personal names and see what the differences will be. Also consider the asset protection benefits.

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

    Lawyer, Mortgage Broker and Tax Advisor (Aust wide) http://propertytaxbook.com.au/

    Profile photo of dreamteamdreamteam
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    @dreamteam
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    Thanks Terry for your comments.  Yes, the accountant did mention that. 

    The bit about existing debt levels affecting the ability to borrow via a trust cam straight out of chapter 9 of Steve McKnight's first book '0-130 properties in 3.5 years' page. 175. 

    Has anyone out there set up a Trust and discovered they could NOT borrow any more than as an individual?

    Profile photo of TerrywTerryw
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    I have been a broker for 9 years and can tell you trusts will NOT help you borrow more – they may even hinder.

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

    Lawyer, Mortgage Broker and Tax Advisor (Aust wide) http://propertytaxbook.com.au/

    Profile photo of dreamteamdreamteam
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    Thanks Terry – How do they hinder exactly? 

    Profile photo of TerrywTerryw
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    Strictly speaking there is no guarantee a trustee will ever distribute to a particular beneficiary. So if you build up a large asset base in the trust and guarantee the loans you will have a large debt by no guarantee of income (if you did have a guaranteed income stream from the trust there would be no asset protection).

    But in practice banks generally will consider the trust income, even other trusts beside the one borrowing, as your own if you control the trust.

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

    Lawyer, Mortgage Broker and Tax Advisor (Aust wide) http://propertytaxbook.com.au/

    Profile photo of dreamteamdreamteam
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    Thanks for the clarification Terry.  I am still unsure overall as to whether or not to set up a trust and purchase IP's through it or purchase them as an individual.  Steve McKnight seems to think the former is by far the better option.  Anyway, I'll crunch some numbers and try to work it out.  Thanks for your input.

    Profile photo of TerrywTerryw
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    Discretionary trusts are the greatest vehicle to own appreciating assets. But they do have some disadvantages in the early stages. If you can get through that hurdle you will be laughing.

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

    Lawyer, Mortgage Broker and Tax Advisor (Aust wide) http://propertytaxbook.com.au/

    Profile photo of Jacqui MiddletonJacqui Middleton
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    Hi Terry, in your opinion, what are the advantages of a Discretionary Trust versus buying in one's own name?

    Jacqui Middleton | Middleton Buyers Advocates
    http://www.middletonbuyersadvocates.com.au
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    VIC Buyers' Agents for investors, home buyers & SMSFs.

    Profile photo of TerrywTerryw
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    @terryw
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    Asset protection
    Tax flexibility
    Estate planning flexibility
    Finance flexibility
    easy to transfer control without changing title

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

    Lawyer, Mortgage Broker and Tax Advisor (Aust wide) http://propertytaxbook.com.au/

    Profile photo of dreamteamdreamteam
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    @dreamteam
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    And the disadvantages are:

    Cost to set up (say, $1500)
    ongoing costs (say $1000 p.a.)
    more paperwork & reporting
    cannot negative gear ie.offset losses against other income
    pay land tax regardless with no tax free threshold

    Have I missed anything?

    Profile photo of Ryan McLeanRyan McLean
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    Sometimes lenders will only lend 80% LVR because it goes through their business section
    For a first deal buying in your own name is sometimes more straightforward and less complicated.

    Ryan McLean | On Property
    http://onproperty.com.au
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    Profile photo of TerrywTerryw
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    dreamteam wrote:
    And the disadvantages are: Cost to set up (say, $1500) ongoing costs (say $1000 p.a.) more paperwork & reporting cannot negative gear ie.offset losses against other income pay land tax regardless with no tax free threshold Have I missed anything?

    Legal Complexity
    Tax complexity

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

    Lawyer, Mortgage Broker and Tax Advisor (Aust wide) http://propertytaxbook.com.au/

    Profile photo of TerrywTerryw
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    ryan mclean wrote:
    Sometimes lenders will only lend 80% LVR because it goes through their business section For a first deal buying in your own name is sometimes more straightforward and less complicated.

    This would generally only be for those trusts with corporate trustee.

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

    Lawyer, Mortgage Broker and Tax Advisor (Aust wide) http://propertytaxbook.com.au/

    Profile photo of Jacqui MiddletonJacqui Middleton
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      Thanks guys

    Jacqui Middleton | Middleton Buyers Advocates
    http://www.middletonbuyersadvocates.com.au
    Email Me | Phone Me

    VIC Buyers' Agents for investors, home buyers & SMSFs.

    Profile photo of Pootie TangPootie Tang
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    @pootie-tang
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    Post Count: 19

    Hi,

    I am still new to the forum and looking at purchasing my first investment property through our family trust.
    After reading Terry's post on "not being able to offset losses against personal income" I am a little confused.

    We really needed to reduce my husbands personal income tax, so we set up a Company with a discretionary family trust (Trustee company) to distribute income to myself and our children in Dec 09.

    The IP we are purchasing will be negative geared and I thought the losses would reduce our Company income?

    Am I confused between the Trust's tax payable and personal tax once income is distributed? 

    I thought this is how it would essentially work at the end of every financial year for tax purposes:

    Company Income (my husbands fee for service work) $250,000
    less his work related expenses                                           (90,000)
    Net income                                                                             $160,000

    $160,000 distributed as follows: $12,000 to our children & $74,000 to myself & my husband and taxed accordingly.

    With an investment property in the scenario negative geared to approx $30,000.
    The costs would be offset against the other Company income my husband generates, reducing net income to $130,000 and then distributed to as follows:
    $12,000 to children & $59,000 to my husband and myself?
     
    Is this correct?

    Pootie. 

    Profile photo of TerrywTerryw
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    @terryw
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    Not really correct.

    A company is a separate tax entity to a trust. Each is a separate person for tax purposes and has to file its own tax return.

    If your company makes $50,000 profit and a trust looses $50,000 from negative gearing, the company income can't offset the loss of the trust with the net result an income of $0.

    What will happen is the company has to pay tax of 30% of $50,000 ($15,000) and the trust's loss has to roll over to next year to be offset by any positive income. If none it keeps rolling over.

    Companies also cannot distribute income flexibly like you have mentioned. The company would have to employ you to distribute money to you, or you would have to own shares and get a dividend. The same with the kids, but depending on their ages they may be taxed at around 66% on unearned income.

    Maybe your company is a trustee of a trust??? This would be different. Your company would only be acting as the legal owner and it is really the trust that is running the business.

    if this is the case then it would be dangerous to put the investment property into the same trust as the business. but if you did the loss of the property could be used to offset the income of the business because it is all with the same tax entity.

    A better way to do it would be for the trust to own shares of the company with the company operating in its own right (not as trustee). Shareholders generally cannot be sued for actions of the company. So when the company operates, it is run by the husband (keep wife out of it) with a small wage paid to the husband, expenses taken out and then the profit distributed to the trust.

    It may even be wise to have a separate trust to own the property and a different one to own the shares. The first trust would make a profit and then this would be distributed to the second one.

    Also you should note that adults can earn up to $16,000 pa tax free now and kids around $3,600 pa tax free.

    all this needs careful set up – and implementation as there a lots of issues such as family trust elections etc.

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

    Lawyer, Mortgage Broker and Tax Advisor (Aust wide) http://propertytaxbook.com.au/

    Profile photo of JJ7JJ7
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    @jj7
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    Hi Pootie,

    I’m not an accountant but if your husband’s company is essentially personal services income you may want to check on the ATO’s “alienation of personal services income” provisions – the ATO doesn’t like structures which distribute $/hr worked type income from the person earning it to others to minimise tax. If there is warranty risk associated with the income or the amount paid doesn’t reflect hours worked (eg fixed price work) then you may be ok – check with an accountant before going too far down this track though.

    JJ

    Profile photo of JJ7JJ7
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    @jj7
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    Hi Pootie (again),

    Sorry – I meant to also say that I can’t comment on the trust structure that you are proposing – I’ll need to leave that to someone more expert – I’m just saying be careful around the personal services income.

    JJ

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