Trusts have been around for hundreds of years and have traditionally been using by the wealthy to protect their assets and pay less tax. While this may sound effective, if you ask around you’ll find that few use a trust structure.
What is a trust structure?
A trust structure is an ownership structure where the legal owner is not the beneficial, or eventual owner, i.e. a person or company owns an asset on behalf of someone else, creating a separation between owner of the asset and who will gain the benefit of the asset.
What are the advantages of a trust?
In the case of a property, a trust structure increases the chances that the asset will not form part of a person’s asset base in the event of legal or creditor action. It also gives the flexibility of distributing both income and capital gains to a group of people at the discretion of the trustee. Under normal circumstances, the rent and any capital gains belong to you, the owner. In a trust situation, they belong to the trust and the trust has to distribute them, or give them away. The trustee can choose who to give the income to based on the terms of the trust deed. But while protecting the asset and being able to distribute the income and capital gains sounds advantageous, there is a downside, resulting in trusts not being as widely used as you would expect.
What are the disadvantages of a trust?
A trust structure can be costly and complex to set up, and can be a similar burden as a company. It will create an extra set of accounts, documentation (such as meeting minutes) and lodgements. It’s usually more expensive to get trust tax returns done than it is for personal returns. You will be subject to greater land tax, as the tax threshold for trusts differs to that of individuals. Furthermore, if you’re buying a house to live in, there may be tax implications for the capital gains tax exemption.
A trust can distribute income, however it can’t distribute a loss. If your investment property gives you tax deductions that you offset against your normal income, a trust structure won’t allow you to use those deductions. A trust will hold onto any losses and only use them to offset profits. Once you take depreciation into consideration, it could take a while until the property is ready to return after tax profits, during which time you won’t be getting any tax relief. For some people, this isn’t an issue. But for many property investors, the tax deductions over the first 10 years are often the key to affordability and pursuing other financial goals such as paying off the home loan.
So which is best?
There is no perfect solution, with each scenario presenting both advantages and disadvantages. What’s important is that you understand what you’re trying to achieve with your property investment and the long-term implications. You don’t want to be changing structures around in the future as you’ll incur potential stamp duty and capital gains tax costs. Seek the right legal, financial and tax advice upfront. There are many factors to consider, and if you don’t cover them all, you could be in for an unpleasant surprise.