Should I set up a trust for my first IP

there are so many issues involved that it would be hard to provide an answer.

It would depend on many factors such as:
– which state will you buy in?
– are you at risk of litigation
– Your income
– You family's income
– any kids
– will the property be producing an income loss
etc

Well, its still difficult to decide because:
– If you use a trust any losses cannot offset your personal incomes. If you add up depreciation expenses, travel expenses then there could be a large loss. maybe $10,000 pa. If in your personal name then you could tax maybe $3,000 in tax. Not so in a trust, unless you are self employed maybe.

– You may have to pay more land tax in Vic if you hold in a trust. I am not sure of the current rules down there.

On the positives, if you have kids, each kid can get approx $3,300 pa in unearned income each year and not pay tax. So if the parents were both working and the property earned $6,000 after expenses then no tax may be payable. If it was owned in personal names then maybe $2500 in tax would have been payable.

But if you don't have kids and are both working and all your near family are working then you may have no one to distribute to so would pay tax just as if you owned it in your own names – or maybe you could cap the tax at 30% by distributing to a company.

Long term trusts will be great, but it can be painful in the early years, especially with the losses and land tax.

Maybe do some cashflow projections and see how it goes. Just assume the trust is a separate person with no other income.

bb8

If you are at risk because of your job, then operating thru a separate company will limit your liability to some extent. It may also allow you to divert income into the trust with the losses so the income from the business can offset the losses. This will reduce your taxable income too.

However, the banks will view this as being self employed and would want to see financials, ideally for 2 years.

Yes, there are various rules to look at. especially the alienation of personal services income rule. Under some circumstances the ATO can deem income earned by a company or trust is actually the income of the person who does the work. Whether you can get around this will depend on your circumstances.

It doesn't really matter who is behind the trust so much as long as everything is done at arms length ie commercially justifiable.

You may be able to divert part of your income into the trust. Just enough to offset the loss maybe.

Limited Recourse – thank you for your comment. I am certainly hoping to achieve a long term goal to accumulate assets and if this means short term losses than so be it, as long as the initial structure is set up correctly..

Terry, thank you for directing me to read about the alienation of PSI rule and in doing so also looked at the general anti-avoidance rules. I think I fall into the category of a personal service business and will not be able to divert my income into the trust without breaking the anti-avoidance rules. I work as a medical practitioner and can elect to be paid as a employee or through my ABN. If someone sues even if I was earning income through a Company B (with myself as the director) I would anticipate the person will sue the company as well as myself personally. So that’s why I wasn’t sure how setting up my earnings through a company entity would offer more asset protection.

I have also read your comments in the threads about family trusts. I think I may have come up with a loan structure based on your advice but not sure if I have understood everything correctly:

We are based in Victoria. Currently my husband and I own a PPOR worth 900,000. We have a P+I loan for 600,000 with an offset account that contains 100,000. Right now we have only paid off about 20,000 of our loan – 580,000 outstanding. Our combined income is 160,000. No kids.

So, we have just leased out our PPOR at 600/week because we will be housesitting for our parents for at least 1-2 years.

We have also paid a deposit for an off the plan apartment in Victoria which will be finished next year. The purchase price is 450,000. We anticipate rental income to be 400/week. The apartment is intended to be our first investment property, and this has been purchased under a family trust – with a company acting as trustees and us being the directors.

The issue is that with the family trust there is no negative gearing. So in order to minimise loss in the trust (which is not tax deductible) my understanding is to ensure the loan repayments for the investment property either equal or exceed the rental income (positive gear).

1. For the PPOR – Change the PPOR P+I loan to interest only loan and maximise the loan to 80% of = approx. extra 140,000 (0.8×900,000 – 580,000) in loan funds. Although the interest is higher with this IO loan of 720,000 – it can be negatively geared against our income given we are renting it out for 600/week.

2. For the Investment Property in the family trust – Get an IO+offset loan, for 80% of the property ie. 360,000. The 20% remainder will come from the extra 140,000+100,000 existing in the bank. Everything that is left (roughly 240,000-45000= 195,000)is put into the offset account for the investment property, so that in fact we will be paying interest on 195,000 not the full 360,000. This will ensure that we are breaking even and in fact, base on 8% interest rates may even mean some positive gearing..

I hope I am on the right track but please point out any deficiencies..

Thanks bb8

Thanks Terry for your advice.

Will be meeting with the accountant in 2 weeks but it has been really helpful at least to learn the basics.  I will speak with him about the service trust but my work equipment is so portable and admin fairly straightforward that I would only be able to justify a small amount of fees to use the service.

In regards to maximising the loan on the existing PPOR now rented out as IP, if we don't do this then won't have enough money to move over to the family trust to "break even".   So technically by increasing the loan amount on the existing property it isn't directly related to the existing property, just being diverted to offset the new one in the family trust to "break even".    Does that mean we cannot tax deduct that portion?

bb8

By increasing the loan you will be reborrowing money. What the money is used for will determine deductibility. If it isn't being used for investment purposes then no deductibility. 

I'm sorry Terry I may have misinterpreted NAB's (who we're with under the choice package) interest rates list.  The IO rate is the same as the standard variable rate at 1 year but it depends on the number of years – the rates get higher as you approach 5 years.

Does one decide how many years they want an IO loan and so then you pay higher interest rate from the beginning (eg. 1 year is 6.74% and 5 years is 7.79%) .  Or is the rate charged based on how many years you've held an IO loan hence slow goes up over time?

bb8