Hi Kelly.

I had a chat to the ATO about this topic

I know you know which this is, but I’d like to clarify for other readers:

The topic is:

Using unit trusts to borrow money personally to purchase units from the trust so it can buy your own home so you can rent it back and claim the interest on the money borrowed as a tax deduction.

The topic is not:

Renting back your own home after you have transferring or sold it to your trust.

It is ok to sell transfer your PPOR to your trust and rent it back. Just DON’T borrow money to buy units from the trust to buy your PPOR and then claim back the interest on money borrowed.

If you have a trust deed that does not allow units, then you can have no problems, because there are no units for you to buy and claim interest as a deduction.

If you have a unit trust, do not claim the interest relating the the units used to buy your PPOR as a deduction.

All other interest on money borrowed to purchase units for OTHER assets are deductible.

1. The purpose of the plan. The ATO said that if the idea was to claim deductions that you would not normally be able to claim, ie. rates, maintenance etc, they would consider it a tax avoidance scheme.
Exactly. Remember, the PPOR costs are now paid for by the trust, so this is not the issue. It’s not about the council rates, or anything, being claimed as a deduction by the owner, because they’re not claiming them! All this is internal to the trust.

The issue is the tax deduction resulting from the interest on money borrowed to purchase the units from the trust.

was to claim deductions that you would not normally be able to claim
Remember, you’re not claiming them, the trust is. If “rate $1,300” show up in your personal tax return, you’re asking for trouble. Your not claiming a deduction for rates, maintenance, etc. It is an expense to the trust.

2. Capital Gains Tax – you loose the PPR exemption…..knew that one already.
I pointed out some reasons above why you would prefer to “loose” the CGT exemption if it fits your strategy.

3. Losses are quarantined in the trust.
Yes. No negative gearing benefits that I’m aware of, but will be offset against future income years, which is far better than nothing.

Also, you get to choose when you’ll bring the loss forward, which works well when you want to retain profits inside the trust (and not pay 48.5% tax) and not distribute them.

they would consider this to be caught by Part IVA (Anti-avoidance section) as a scheme designed to avoid the payment of taxes.
Understandably so. If I were to claim someone else’s travelling expenses as my own, they would fine me, or worse.

If I were to claim deductions myself in what is an otherwise personal financial matter, the same applies.

From Terry:
This is a Tax Ruling on renting you home from your Unit trust

It is not about the trust claiming council rates as a deduction on a propery you rent from the trust, whether you previously owned it or not.

It is about an individual claiming deductions they would otherwise not be allowed to claim.

That is, the ineterest on the money used to buy the units is not deductible for the property they occupy.

So if you want to borrow money to buy units in your trust to purchase your own home with so you can rent it back, DO NOT claim the interest as a deduction.

Michael

Hi David. I can’t explain James strategy, you’ll have to ask him, but when you said:

Seem to me all James is interested in is, paying extra tax!!

I don’t think this is correct. You are right that James will pay extra tax, especially at set up, but I don’t think it is his only “interest” to pay more tax.

I understand that with the scenario he has put forward it seems that it is all outgoing to set it up, and the future benefits may seem dubious, at best.

However, there are benefits of having your own home in a trust:

1. Trusts are good for 80 years. This means that, provided the beneficiaries are identified in the deed, you could have the assets providing financial benefits to two, three or possibly four generations of the one family.

If you owned your home, when you sell at retirement to cash in, it is GCT exempt. That’s fine. But if you want your kids (now adults) or other relatives to benefit from the asset, they would have to buy it, pay stamp duty, etc, when you retired. If every generation did this the amount over time may be substaintial.

However, by keeping the asset in the trust, when you retire you can still receive the benefit of the income stream wihtout selling it. When you die, the income stream benefits will go to other beneficiaries, etc.

If you, as trustee wish to sell it when you are retiring, you still have that option, and depending on how you income split it (say between husband and wife, kids, grandkids, etc), you could still pay zero tax.

My point here is that few people are setting up their invesment structure for more than retirement age, or if they are, it is only up unitl they die.

Also, CGT is a boogeyman. It scares too many people into making the wrong decision.

2. Trustee can evolve over time. While the trustee may remain the same (say a P/L), over the years the directors can be added or altered so that it is progressively “handed over” to the next and subsequent generations.

The wealth and control of the wealth remains in the hands of the people it was intended to provide for.

To answer some of your specific questions, again, not knowing James intentions:

From what I understand from his post, if he places the property in either a trust or company, he says that he will be taxed at a lower rate than his marginal tax.

This could be true. If James is earning good money, having a P/L beneficiary may be a better way of paying less tax.

If the company is the owner of the asset and not a trust, there are exemptions at 15 years for assets producing income. It works out no different to CGT exemption.

He seems to be suggesting that his property will be making a profit and paying some amount of tax. Why would you want to do this??
In a trust, any undistributed funds will be taxed at a flat rate of 48.5%. If this isn’t much more than James’ personal flat tax rate, it may make more sense to pay the extra tax and leave it in the trust for the trust to re-invest.

In a company, profits will be taxed at 30%, and the same may apply. Horses for courses.

While minimising tax as much as possible, I would be pleased paying $50K of tax than paying $20K of tax, all things being equal. Generally, the more tax an entity pays, the more profit it is making.

And on top of this he would have to pay capital gains tax on sale, plus if the property was put in a discretionary trust, he would have to pay land tax.
The trust does not have to sell it for 80 years and the CGT is based on the beneficiaries income tax for that year, and so the tax payable may be quite low or nil, as mentioned above.

The P/L could sell after 15 years and effectively have it CGT free.

Land tax may or may not be an issue. It depends on the property value.

The only explaination I can come up with if that he is worried that he could lose his house because of his occupation it at risk due people sueing him.
This could be true.

If that is the case, and he had a partner, wouldn’t it be better to transfer to his partner.
What if his partner pays more tax than James? The situation would be worse. Also, all the trust benefits are lost, ie, the ability to distribute what income types and amounts to which beneficiaries; the 80 life; the asset protection; etc.

It also may involve James’ partner applying for a loan, which they may not be eligible for, regarless of income. I don’t know their personal and financial situation, I’m just pointing out reasons why it may make less sense to transfer to a partner than transferring to a trust or P/L.

It all comes back to purpose, strategy and goals.

Michael

It’s my FAVOURITE question. Thanks for asking it.

Shares do not have a vacancy factor. Try liquidating just 745 bricks in your house. What is a better way of owning part of a progressive company without having to buy it outright? Try buying and selling the same property 4 times in one day with a profit at the end. Ever seen a Daytrader not transfixed by a computer screen? It’s a great computer game and there’s always the opportunity of realising far better than the promised return of 87% on poker machines.

Warrants, put options, margin lending, derivitaves .. allow for a profit even when the share price drops. Make money on the way up and also on the way down.

However .. a full loss on shares means a full loss. Zero. Bricks will retain some value. Rents may remain constant even as market value drops. This is cashflow as Steve purports. Steve’s risk lies within a reasonable jump in interest rates, which could push marginal positive cashflow over the line into negative. This is when a fire sale may occur, to minimise losses.

The underlying answer is not in which investment is better. Personalities, risk perception, feeling of control, excitement, long term, short term growth .. it’s about the individual’s circumstance. There will be as many answers to this question as there are the number of positive and negative experiences in each.

Kind regards to all, Phil

Hi There

I have just had two valuations done with westpac, they called me two days later and gave me the valuation figures. Had a val done 2 months ago with CBA through a different valuer, their figures were a considerable amount higher, I am also in a high capitol gain area, Figure that one out.

There are several solutions :

1. if the house will value at more than the purchase price some lenders are prepared to increase the loan amount based on the higher valuation. One hitch though is the fact that before you can apply for an increase in the loan amount the property has to be first registered in your name. So there may be a three weeks or so delay after settlement in getting the increase in laon amount.

One therefore needs a friendly soul prepared to lend you the shortfall for a say four week period. It could be one of your parents, it could be a brother or sister or it could be the mortgage broker perhaps ?

2. Ask the vendor to carry an unregistered mortgage for the shortfall. This may cause problems with the first mortgagee. So even though any such loan is drawn up as a mortgage the lender can only register his interest by placing a caveat on the property. (which is a pretty good way of protecting the second mortgagee’s interest).

You may however encounter a problem as some lenders ask for evidence that you have the deposit which is needed to complete the purchase sitting in your bank account.

That problem too can be solved creatively.

Some unscrupulous people solve the shortall situation by coming to an arrangement with the vendors to increase the purchase price and then they are given a discount on settlement because of prompt settlement.

That however amounts to fraud as you are actually inducing the lender to enter into a lending situation where the full facts have been witheld from him.

The fact that this type of thing is probably being done each and every day doesn’t justify you doing it though.

Perhaps some others may be able to make some other suitable suggestions ?

Pisces133

Scremin, it is possible to get a 97% or even a 100% loan.

Now if that is your first home then you would be able to also obtain the $ 7 K government grant as well as a reduction in stampduty.

Thus your $ 10 K may enable you to buy a second property ?

Now all that assumes that you have a job to support any shortfall.

To obtain a loan the lender would generally be looking for stability in your employment record.

Some people of course actually fudge that a bit though that is of course not at all what I am suggesting you do. I mention this only out of academic interest.

Generally a couple of recent payslips would be sufficient evidnce for a lender. Expect however that the lender will make enquiries whether you are actually emploed where you say you are employed.

Your gross job income together with 80% of any rental income would be taken into account by the lender.

Now if your friend is doing the same then between you you would be able to buy four properties ?

What income is needed to qualify for a loan ?

Well, as a rough rule of thumb, if you take 8% of the loan amount, multiply that by 3 then that amount should not exceed your yearly gross income.

Cheers,

Pisces133