What Structure Should I Use to Purchase a Property?
This information has been prepared as a general guideline, and is not intended to be an exhaustive or a complete analysis. Before taking any action or implementing any strategy you should seek professional advice from your lawyer, accountant and or financial planner who will take into account your specific circumstances and objectives.
Purchasing and holding any asset can be done via many different structures, the most familiar being individuals and companies. A third structure also exists and is called a trust.
Trusts have been in use since probably the 13th century so they have a wide and significant application in society. A trust structure is a tool for investors and businesses owners. The main benefits of a trust structure are that it provides flexibility re distribution of income (Income/capital gains can be distributed to various different people) they provide asset protection (the trust owns the asset not the beneficiaries who may be sued) and improved estate planning (control of the trust ie the trustee can be handed down but ownership does not change). The basic function of a trust is to separate control and ownership.
A trust is merely a relationship or promise between different entities. In simple terms a person or company (trustee) agrees to hold assets for the benefit of another (beneficiaries). All rights and benefits are subscribed to the beneficiaries although they do not show up anywhere as “the owner”. The way the benefits are passed down to the beneficiaries and the way the assets are managed by the trustee are dictated by a set of rules “the trust deed”. There is no “one size fits all” set of rules as they can include anything (legal of course) and are only limited by the imagination of the writer.
It is the name of the trustee that appears on all documents such as a land title certificate, bank accounts and lease agreements etc. Behind the scene however is the trust deed and an appropriate resolution identifying that they are acting only as a trustee for that particular trust. The trust deed then identifies who the beneficiaries are. Sounds complicated, but hundreds of years have shown it is relatively easy. Below is a diagrammatic representation.
There are many types of trusts and they are all used for different purposes. The more commonly used are a family trust, a hybrid trust, a Property Investor Trust, a unit trust even a self managed super fund is just a trust but with very special rules.
Care is needed to identify the correct set of rules and therefore trust type needed for a particular usage. As an example when purchasing a property it would not be advisable to use a family trust if the property was negatively geared for a period as you cannot personally use the losses. Where negative gearing is an issue it would be better to use a Property Investor Trust (PIT) where you as the investor borrow funds to invest in the PIT to receive the income and capital which will then allow you to claim the interest on the borrowed funds. The PIT then uses these funds to purchase the property. Care is needed to ensure you comply with ATO requirements.
If a property is purchased in an individual’s name then limited flexibility is available and asset protection is not generally available and estate planning becomes too rigid. If purchased in a company the same issues arise plus a company does not receive the 50% CGT general discount. Using a trust is by no means the “must do” structure as trusts can increase land tax costs in some states and have a small degree of additional administration over say, purchasing in an individual name. Before deciding on which structure is best suited for your needs specific advice must be sought.
Specifically, if the PIT holds a property which was positively geared, the trustee can each year decide on which beneficiaries they will distribute the income (similar for any capital gains). This split can change from period to period and so there is no fixed requirement for any beneficiary to receive a distribution. If on the other hand an individual investor borrowed funds to invest in the PIT they would have a fixed entitlement to the income and capital and so all (or proportionally if several different investors) the distribution would go to them and they would then, in their tax return claim the interest expense. In this example if the individual was sued successfully (they ran over someone’s foot in the car park) and insurance was not available or rejected by the insurer, then the assets in the trust (remember you do not own trust the assets) would not be available to your creditors yielding efficient asset protect.
Any assets in the individuals name however, would be available to these creditors. For estate planning purposes the position of trustee could be handed over to another family member thereby changing control of the trust (remember trustee decides who gets what unless fixed entitlements are in force). This in itself has no CGT or stamp duty liabilities.
Distributions of capital gains from a trust to individuals receive the 50% general discount and the tax rates on income or capital distributions attract that beneficiary’s marginal tax rate which is therefore not the same for everyone.
While not specifically covered in this article, similar benefits and advantages can be achieved by business owners operating through a trust as compared to operating the business as a sole trader or through a company.
Ken Raiss – Director Chan & Naylor
If you want to discuss any of the strategies please contact Chan & Naylor via
www.chan-naylor.com.au or on 1300 250 122 where you will be able to arrange a suitable time to meet with one of our team.