Can someone please give me an explanation through illustrations on how a hybrid trust (and what’s so special about hybrid?) can be used to buy a property where a loan is involved.
How can the higher tax earner claim in the trust claim tax deduction for interest paid? and whether rental earnings from the property can be distributed ONLY to the lower tax earner?
Thanks – BlueToba
I am not an accountant, but….
eg. Mr X sets up The X Hrbrid trust with X Pty Ltd as Trustee.
A property is purchased by X Pty Ltd as Trustee for X Hybrid Trust.Mr A then approaches a bank and asks for the loan to be in his personal name, with the loan being securred by the property.
An accounting entry is made to indicate Mr A is buying a number of units in the trust for $xxx.
At tax time, Mr X claims the interest on the loan against his other taxable income.
The trust usually makes a profit (because it is not paying interest). This profit can then be distributed at the trustee’s discretion. I am not sure if all or at least some of the income has to be distributed to the unit holder (to make a relationship between claiming an expense and making an income).
I don’t use a hybrid trust and am not sure that is entirely correct, so please check with an accountant.
Terryw
Discover Home Loans
North Sydney
[email protected]Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
Thanks Terryw!
1. In relation to distribution of income, I can understand that for the purpose of claiming deduction on interest of the loan you must have used that loan for income producing purposes. However, in light of HDT is it still possible to distribute some income to other benefeciaries other than the member who borrows from the bank? Can anyone comment on that?
2. On buying a brand new property, where the building depreciations and deductions are large in the first years and say outstripping the rental income. The trust will end up with a loss (even without interest payments). Can you still pass on this loss to the person who took the loan as further tax deductions? or must this loss be rolled over to the following years?
3. Where the loan in interest only loan; and say the answer to Question 1 is that the rental income must be 100% be offloaded to the person who took the loan for it to be a genuine tax deduction. Many many years later when the property genuinely becomes positive gearing as rental income increases, how can you distribute the income to other beneficiaries whilst still claiming tax deductions on interest only loan repayments?
Thanks
Blue,
TerryW has given a pretty good breakdown of how the hybrid trust operates. You also need to be sure
1. The trust deeds are in place before the exchange of contracts;
2. Appropriate resolutions will need to be made with respect to the issue of special income units, purchase of the property, etc.Income will need to be distributed to the special income unit holders based on their holdings. If you have issued all the special income units to the highest income earner then they will need to receive all the income from the rental property otherwise you will have an issue with respect to deductibility of interest on the loan.
Obviously you can issue special income units and redeem them and reissue as you and your accountant so desire but you need to be aware of the implications of doing so. Sit down with your accountant on this one.
Trust losses will need to be carried forward but this is subject to a number of rules regarding the carrying forward of trust losses. If the trust has made a family trust election then the rules are a bit more relaxed but again their are pros and cons associated with a FTE. Again discuss with accountant.
With respect to your third questions you can redeem the units and then reissue them to another beneficiary. Again another chat with the accountant.
You will also need to discuss with your accountant whether you want to purchase the property in a hybrid trust or in a unit trust where all the units are owned by a hybrid trusts. There are some fantastic planning opportunities if you purchase the property using this structure as opposed to purchasing the property directly into the hybrid trust. Extra costs involved but you need to be aware of the future benefits.
Hope this helps.
1. In relation to distribution of income, I can understand that for the purpose of claiming deduction on interest of the loan you must have used that loan for income producing purposes. However, in light of HDT is it still possible to distribute some income to other benefeciaries other than the member who borrows from the bank? Can anyone comment on that? – I don’t think it is possible for the trust to distribute some income to other beneficiaries other than the one who borrows and purchases all the units in the trust. All trust income (after expenses) must go to the one who owns all the units in the trust.
2. On buying a brand new property, where the building depreciations and deductions are large in the first years and say outstripping the rental income. The trust will end up with a loss (even without interest payments). Can you still pass on this loss to the person who took the loan as further tax deductions? or must this loss be rolled over to the following years? – Only trust income should be distributed. All trust losses are quarantined in the trust to be offset against future income, ie rolled over to the following year(s).
3. Where the loan in interest only loan; and say the answer to Question 1 is that the rental income must be 100% be offloaded to the person who took the loan for it to be a genuine tax deduction. Many many years later when the property genuinely becomes positive gearing as rental income increases, how can you distribute the income to other beneficiaries whilst still claiming tax deductions on interest only loan repayments? – The brief answer to this is that when the property becomes net positive cash flow in the future, the trust will then borrow the funds to re-purchase the units from the one who owns them (this person will pay out his loan with the bank). The trust will now have a loan, but after all expenses, there will be a net positive cash flow. This net cash flow can then be distributed to whomever the trustee chooses (this is where it becomes discretionary) – that is, to the low income earner, instead of the high income earner. You will need to check with your accountant when that time comes.
Thanks to those who replied.
There is one point I’d like to raise, which is based on the latest WealthGuardian 2005 (page 77). It says “…there are some key advantages to using a hybrid trust so that tax losses can flow through to beneficiaries rather than remain locked inside the trust structure”. Unfortunately, no explanation was given.
This appears to be different to the common belief. Does anyone have any comment.
Cheers!
My understanding is that tax losses cannot actually flow through a trust. Not even a hybrid can distribute losses. The only way around this is for the interest to be claimed personally as the above describes.
Terryw
Discover Home Loans
North Sydney
[email protected]Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
Hi Babu88,
Just with your comments below:
“The brief answer to this is that when the property becomes net positive cash flow in the future, the trust will then borrow the funds to re-purchase the units from the one who owns them (this person will pay out his loan with the bank).”
I read that in Trust Magic as well and was trying to work out how it would work operationally. The way I see it, you would need to approach the bank (or another) to re-finance and will probably be hit with discharge fees and new mortgage duties to replace me as borrower with the trust. Is this how you see it too?
I know this is off topic but do people out there pretty much think TR2002/D2 kills the availability for a borrower to rent from the hybrid trust? I’ve read a few posts here and majority think apart from get your own advice is that one should be careful and at least attempt to show that tax is not the main reason like not only buying that one IP in the HDT. In reading this TR though, it pretty much kills it for unit trust arrangements. Any thoughts much appreciated – even if you know someone who knows someone who may be using this structure. Thanks in advance.
Asdf
That link was to the draft ruling. The full ruling is
TR 2002/18 Income tax: home loan unit trust arrangement
http://law.ato.gov.au/pdf/tr02-018.pdf.Maybe one way to get around things is to distance yourself a bit futher from your trust’s property. eg, could a friend or relative rent the property from your trust and allow you to live there?
Terryw
Discover Home Loans
North Sydney
[email protected]Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
Just with your comments below:
“The brief answer to this is that when the property becomes net positive cash flow in the future, the trust will then borrow the funds to re-purchase the units from the one who owns them (this person will pay out his loan with the bank).”
I read that in Trust Magic as well and was trying to work out how it would work operationally. The way I see it, you would need to approach the bank (or another) to re-finance and will probably be hit with discharge fees and new mortgage duties to replace me as borrower with the trust. Is this how you see it too?
Hi adsf
Sorry I don’t really know the answer to your question because we have not crossed that bridge yet. We have set up a HDT a few years ago and understood the concepts broadly. When the time comes hopefully our accountant will advise us the procedures.Thanks for that Terryw. Might be a bit troublesome to show audit trail for rent to come from family/friend but for all purposes, I could argue that its just like any other IP. Might continue to use parent’s address for correspondences with ATO/electorate so it doesn’t create alarm bells with me claiming deductions from IP owned by the trust which I’m also living in. I know a lot of accountants are not big advocates of this strategy so will see. Thanks again.
Hybrid trusts are high in maintance and if not used correctly are worthless.
Unit trusts are far to easy to workout how much each unit is worth eg trust has $1 000 000 asset. 2 unit holders are worth $500 000 each.
I use discreationary trusts(not family trusts). The asset protection is equal to ANY other trust and far more flexible( and easy to use). If set up correctly they can also protect assets OUTSIDE the trust.
The profits can be distributed to anyoene over 18 or a bucket company to cap the tax at 30%.As far as an accountant is concerned, these are LEGAL structures. Don’t get me wrong there are some good accountants out there, but they are accountants and good trust structures can be a specialty in themselves.
Colin Wardle
CATA Asset Protection
[email protected]Cata,
Asset protection is not the only reason that people are using hybrid discretionary trusts. Unless a trust can issue special income units (neither a unit trust or discretionary trust can) then how can you negative gear through these entities. Most of my clients have hybrid discretionary trusts to obtain the asset protection benefits of a trust AND to obtain the negative gearing benefits associated by having a hybrid trust. What about the refinancing principle ? Another fantastic tax planning opportunity only available through the proper use of a hybrid discretionary trust.
For those who want to transfer residential property to a superannuation fund at a later stage may also want to have a more flexible/yet more complex structure where a unit trust holds the property and all the units are owned by a HDT. If the residential property was purchased in a HDT however this could not be transferred to the Super Fund. This cannot be done with residential property held in a discretionary trust. It is a breach of the SIS Act.
I agree that they are complex vehicles but if managed by a competent accountant then it is not overly complex. The flexibility from a tax perspective is considerable. The other structures have their benefits but also their disadvantages. That is why a one size fits all will never work for everyone. For some people a HDT will be useful for others a Discetionary Trust may provide sufficient advantages whilst for someone else a Unit trust or combination of one or two of these may be appropriate.
The setup and ongoing costs are no more expensive than a standard unit or discretionary trust. As far as the deeds are concerned all my trusts are prepared by Chris Batten and his team in Macquarie Street, Sydney. Considered by most to be one of the finest tax specialists when it comes to structures. His team includes some of the finest lawyers in Sydney so I have no concerns regarding their deeds. For the more intricate matters they are also available to answer questions for us practitioners.
Coastymike,
Originally posted by coastymike:Trust losses will need to be carried forward but this is subject to a number of rules regarding the carrying forward of trust losses. If the trust has made a family trust election then the rules are a bit more relaxed but again their are pros and cons associated with a FTE.
May I ask a few questions to elaborate on trust loss and FTE rules?
1. If no FTE has been made, then any losses (either capital or income) at the end of the financial year are completely wasted? Are they simply written off the b00ks so that the next financial year starts at profit $0 again (from a tax point of view)?
2. If a private company is fully owned by an HDT that hasn’t made an FTE, does that also stop the company from carrying forward losses? (I read something about that recently)
In my likely scenario at the end of this financial year, where I’ve only been operating the trust for a few months and investing in shares, I’m probably going to have a small realised capital loss and some dividend income, mostly fully franked but also where the shares have mostly not been owned for 45 days (thanks to the price falls back in March and April). So does this mean my capital loss and most of the franking credits will be wasted?
Thanks.
GP
coastymike
Some valid points, one size never fits all but you can change the size and shape of a discretionary trust sooooo many ways.Setting up any trust HAS TO BE FOR ASSET PROTEcTION( as far as ASIC is concerned)
Negative gearing can be used to great affect using a discetionary trust. You can quite easily protect assets outside the trust, in doing so getting all the benifits you mentioned. Also being able to protect the principle place of residence without CGT, land tax ect, while also being cost effective.
Sounds like you are an accountant with his head screwed on the right way and it is good to see. I have seen some shockers.
I think we are leading this forum out of many peoples depths. If you want to continue just e-mail me.
GreatPig,
Capital losses are treated differently to revenue losses. The trust loss provisions do not relate to capital losses. These capital losses should be able to be carried forward and offset against any future capital gains made by the trust. The capital losses can not however be distributed to the beneficiaries to be offset against any of their personal capital gains.
With respect to a related company and revenue losses you will need to discuss with your accountant whether a FTE needs to be made for the trust and whether an interposed entity election needs to be made for the company.
Cata,
Don’t disagree that strategies can be developed for protecting your family home, etc through the use of a discretionary trust, without the stamp duty and CGT implications. Agreed that these strategies are best discussed with an advisor and not in the forum and is why I didnt want to make any comment on them.
Would be interested to hear your strategies on negative gearing through a standard discretionary trust. Not quite sure how you get around the test in Ure’ case re purposes for borrowings but always willing to discuss these issues. Ill take this one offline.
I’ll also qualify that with any structure I recommend to my clients I always instruct them to seek the advice from a solicitor/lawyer as there may be many factors that impact on their decision. From my perspective I am purely concerned about tax but they also need to consider insurance issues, legal issues, family court issues, etc. which are all outside of my area of expertise. Personally I wish more accountants and lawyers would work hand in hand regarding structuring because it would save a lot of pain later on for those clients.
Didnt realise you are a new member but welcome.
Coastymike,
Originally posted by coastymike:The trust loss provisions do not relate to capital losses. These capital losses should be able to be carried forward and offset against any future capital gains made by the trust.
Thanks. That’s good news at least [
].Fortunately I don’t have any revenue losses to worry about right now. And the issue with franking credits is mainly just going to be an added paperwork hassle.
GP
coastymike
All the benifits of owning the property in your name
while being protected is my favourite. This can also be used for existing IP’s or any other assets without CGT, stamp duty etc.You end up with a negative equity on paper(and who will sue you if you have less than nothing) but not actually changing your equity. This will stop most law suits and a few little tricks will stop all but the lawyers that will stop at nothing(even though this will be a very expensive for them)
The IP title is still in your name so you get all those benifits. I LOVE IT.
Colin Wardle
Asset Protection Specialist
CATA Asset Protection
[email protected]Cata, can you explain how you can include your family home in a trust without incuring stamp duty etc but still excempted from CGT? If the home is still under your name than it’s not own by the trust. To be protected it has to be under a trust name? Please explain, I am very interested to know how this works.
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