All Topics / Finance / Can trusts increase burrowing capacity?

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  • Profile photo of wan0151wan0151
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    @wan0151
    Join Date: 2019
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    Hi all,

    I have around $1 million dollars of equity in my properties ($800k in my house, $250k in my IPs) but I can’t purchase more properties due to my limited income: $130k. It is frustrating because the Commonwealth bank says I can’t burrow enough to purchase another property even though I have perfect credit and a bunch of equity. I did some research into forming a trust to burrow money in it’s name rather than mine to reduce my personal liability but apparently it doesn’t work that way? I’ve been told that trusts are good for asset protection and not much for burrowing capacity? I did some research on companies and they can increase burrowing capacity but the upfront costs and maintenance fees are rather large. I’m just wondering what the best route is to take? My main goal is to just burrow as much money as possible to buy more IPs. Any help on this would be greatly appreciated :)

    Profile photo of TerrywTerryw
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    @terryw
    Join Date: 2001
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    trusts can’t borrow as they are not legal entities, but holding assets as trustee can improve borrowing cap, if the trustee is a company. I have written about this on here before.

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    https://terryw.com.au/
    Email Me

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

    Profile photo of Steve McKnightSteve McKnight
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    @stevemcknight
    Join Date: 2001
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    Yep – this old chestnut!

    I suggest you search though the forums as plenty has been written on it.

    Highlights:

    > If you have maxed out your borrowing in your own name then you won’t be able to leverage your borrowing ability elsewhere. Maxed is maxed.

    > As Terry has said, Trusts cannot borrow in their own right (they are not separate legal entities as such), but the Trustee usually can (see Trust deed permissions)

    > Trusts cannot distribute losses, so buying -vely geared property in a trust has limited benefit as the loss is ‘locked’

    > -vely geared property in a trust will require personal guarantees from the Trustees if individuals, or directors of corp Trustee (if company), so this will still hurt your personal borrowing ability

    > Only +vely geared property that has sufficient cashflow and credit standing meet the serviceability requirements of the loan will meet the requirements I mentioned in the book. And then only if you have someone from the lender / mortgage broker who knows what they are doing.

    Example: I am about to buy a $1m commercial property with $100k net income. if I buy this in a new trust, then the loan will either not need a guarantee as it can stand on it’s own, or if it does, there is no impact on my personal borrowing ability as the property is self-liquidating (i.e. loan repayments fully met from income).

    Need further help? Make an enquiry and speak to Chris Berry: http://www.propertyinvestingfinance.com

    Bye,

    Steve McKnight | PropertyInvesting.com Pty Ltd | CEO
    https://www.propertyinvesting.com

    Success comes from doing things differently

    Profile photo of wan0151wan0151
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    @wan0151
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    Yep, I’ll definitely have a look. Thanks a bunch guys, I appreciate it :)

    Profile photo of TerrywTerryw
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    @terryw
    Join Date: 2001
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    Here is a copy of an article that I wrote back in 2016:

     

    Trust Strategies to Increase Borrowing Capacity
    Here are a few of examples of how using a discretionary trust can increase borrowing capacity.
    Example 1

    Trust is set up to own property. Property increases in value. But the director of the trustee has suffered a credit blemish and no lender will lend.

    Solution – change directors!
    Get legal advice first!

    Example 2

    Trust is set up to own property. Property increases in value. But the director of the trustee no longer is able service with just his income and the trusts rental income.
    Solution – bring the spouse on as a guarantor. You could do this with properties in personal names as well.
    Solution 2 – bring a friend on as a guarantor. The friend may need to be a beneficiary of the trust and/or a director of the trustee.

    Get legal advice first!
    Example 3

    Trust is set up to own property. Property increases in value. The director of the trustee suffers a court judgment and no lender will lend to him. If this was a property in his own name he would be stuffed for 5 years but with a trust there is a simple solution:
    Solution

    Director causes spouse/friend to be appointed director and then resigns. The loan is then refinanced with the new director providing a personal guarantee.
    Get legal advice first!
    Example 4

    A trust is set up to own property and loans are obtained with personal guarantees from person A who is the director of X Pty Ltd the trustee.
    After a while person A sets up a new trust with a new company Z Pty Ltd as trustee and himself as director. Person A does not tell the new lender about the personal guarantees he has given to the lender for the first trust. Since the new company, Z Pty Ltd, is a separate legal entity to the first company X Pty Ltd, its debts need not be disclosed.
    If the lender asks person A about any personal guarantees he has given he should disclose those guarantees. If the lender does not ask person A need not disclose. Thus the borrowing capacity could be increased by setting up new entities.
    This method has been promoted by a certain property author and criticised by various brokers, including myself in the past because the new lender would know about the personal guarantees given by person A as there would be a record on A’s credit file. However as time passes these credit file hits become less of an issue and will disappear from the file after 5 years.
    Get legal advice first!

    =

    But before doing anything described above each person and the trustee should seek legal advice as there are various legal implications involved.
    To be balanced, here are some ways a trust can hinder borrowing capacity.
    Example 5

    The property’s rent is less than the interest on the loan.

    Lenders will not be able to use negative gearing addbacks because the trust has no other income and it does not pay tax. This will reduce serviceability slightly.
    Example 6

    The property has a taxable loss of $10,000 per annum.

    This could potentially save the individual $5,000 per year in tax but would result in a $10k carried forward loss for the trust with no immediate tax benefits unless the trust had other income.

    This has 2 effects

    Less cash to pay down non-deductible debt
    Less cash flow making it slower to build equity.

    Trusts are complex legal arrangements so see your lawyer before attempting any of this on your own.

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    https://terryw.com.au/
    Email Me

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

    Profile photo of TerrywTerryw
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    @terryw
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    Example 7
    For a person with a credit blemish a Fixed Unit Trust could be set up to own property with person A owning the units of the trust and person B being the trustee.Person A would be the one with the blemish and once that disappears person A could become the trustee and the beneficial and legal interests would merge and the trust disolve – probably without CGT and stamp duty if set up correctly.
    I did this years ago for a client with a loan involved and the lender did not check the trust deed very well and approved the loan on the basis of the income of person B only.

    And another

    Example 8
    Very similar to the above. Person A acts as trustee for person B. B has the credit blemish in this case and the bank will lend on the basis of A being the legal and beneficial owner of the property.

    At a later date title could be transferred without stamp duty and CGT being triggered if set up correctly.

    This is a bare trust arrangement.

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    https://terryw.com.au/
    Email Me

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

    Profile photo of TerrywTerryw
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    @terryw
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    Example 9
    Trustee company owns property and suffers a court judgment. Lenders will no longer lend.

    Solution
    Appointor can appoint a new clean company as trustee.

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    https://terryw.com.au/
    Email Me

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

    Profile photo of wan0151wan0151
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    @wan0151
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    Hey Terry,

    Thanks for all that information, really helpful. My question would be this: If I purchase a 700k property as a trustee through a $250k LOC using the equity in my house (LOC funds the 20% deposit, all other associated fees with owning the house including monthly repayments), would this loan structure affect the burrowing capacity of myself as the trustee? Both yourself and Steve have said that if the property costs money to own (eg: repayment>rent), the losses cannot be distributed and due to needing personal guarantees from other directors/trustees, it will decrease burrowing capacity. However, if the LOC takes care of the monthly difference (eg: $300 a month), there’s technically no taxable loss right? I’m a bit confused about this concept so any feedback would be greatly appreciated?

    Profile photo of TerrywTerryw
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    @terryw
    Join Date: 2001
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    Yes it would as it is your debt. best to have a company as trustee.

    You would have an added issue too in that a trust is not a legal entity but is a tax entity, so could the trust claim the interest on your loan? I have a private ruling application in with the ATO at the moment asking this very question.

    I also don’t understand what you are saying about the taxable loss.

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    https://terryw.com.au/
    Email Me

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

    Profile photo of wan0151wan0151
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    @wan0151
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    If I understand you correctly, the company is the trustee of the trust and I am the director of the company. Therefore, I have full control of my assets but the liabilities fall under the company’s name and not my own, therefore not hampering my personal liabilities.

    About the taxable loss, what I mean is that the repayments don’t come out of your savings account but instead the LOC funds them so when a bank is calculating your serviceability, those monthly repayments don’t come up under personal expenses every month. Basically there are no out of pocket costs to purchasing and keeping the property for a few years. Would that increase your serviceability due to the zero out of pocket costs or does it not make a difference?

    Profile photo of TerrywTerryw
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    @terryw
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    They are not your assets if held on trust. You might control the trust and be a potential beneficiary though, but just remember this control is only temporary.

     

    If you are paying money, even from a loan account, to the trust then that is something that will work against you in servicing – whether there are losses or not. You will also have some legal and tax issues as well.

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    https://terryw.com.au/
    Email Me

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

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