Choosing the right ownership structure when buying an investment property is key as it has serious implications, both legal and financial.

Trusts are now becoming a less popular choice across Australia due to tax, asset protection and estate planning implications. A trust allows a person or company to own assets on behalf of someone else or a group of people.

What is a trust?

To understand what a trust is, it would be best to begin with what a trust is not.

A trust is not a legal entity – like you or I are, or like a company is. Essentially, a trust is a relationship between legal entities.

Although there are many different types of trusts, the main types are as follows: discretionary trusts, often called family trusts, unit trusts, and hybrid trusts, which are special types of trust that are a combination.

Basically, trusts separate legal ownership from “beneficial ownership”. The legal owner is the formal, registered owner, and normally has the power to decide how to deal with the trust property. The beneficial owner or owners on the other hand have the right to receive the benefit of trust property.

How does a trust work?

Trusts are often set up with the help of a professional, usually a lawyer or accountant. The rules of the trust are laid out in a document called a “trust deed”. It sets out the rules of the trust and the names of the parties involved.

For example, in a discretionary trust, these are the parties that will typically be involved:

• The Settlor: this is someone who creates the trust, usually an accountant or lawyer. This person usually has no involvement in the operation of the trust once it’s established and is generally excluded from receiving any benefit from the trust.
• The Trustee: the legal owner of the trust property, a person or often company, who is in control of the trust and makes the decisions.
• The Appointor or Principal: is the person who has the power to appoint, remove or replace the trustee.
• The Beneficiaries: these are the people who are the “beneficial” owners of the trust property. Usually the trust deed will name one or two individuals as beneficiaries while the rest will be defined by their relationship with those people.

Along with the parties involved, a trust must have trust property. It’s common for discretionary trusts to be established with initial “trust property”, usually a nominal amount of cash, either $10 or $100, to be “settled” on the trustee by the settlor for stamp duty reasons.

Usually, the settlor and the trustee signs the trust deed and may need to pay stamp duty, depending on which state of Australia it’s established in.

In Queensland, discretionary trusts created with cash settlements don’t have any duty payable, and are not required to be stamped. In NSW, however, stamp duty must be paid within three months of the creation of a trust.

What are the benefits of buying property in a trust?

The biggest benefits of buying property in a trust relate to:

• asset protection
• taxation flexibility
• estate planning

Separating legal and beneficial ownership creates a “high level of asset protection for beneficiaries”, specially with discretionary trusts, a common choice for property investors.

The trust property is distinct from their own property, so if they come under attack by creditors, the trust assets will often be protected.

From a taxation perspective and provided the trust is properly run, trust income is normally taxed in the hands of the beneficiaries. For discretionary trusts, the trustee can decide where to apply income generated by the trust assets each year.

A trustee may choose not to distribute to a beneficiary, who is already paying tax at a high marginal rate, trust income in favour of a beneficiary who has a lower, or minimal tax rate. Other types of trust, such as discretionary trusts, can also access a range of capital gains tax concessions.

In an estate planning perspective, a trust can be a way of limiting an estate’s “exposure to challenge by disgruntled beneficiaries”, or can even be created as part of the estate plan to provide a higher level of asset protection and taxation flexibility. These are testamentary trusts and are becoming an increasingly popular estate planning tool.

What are the things to be wary of when buying property in a trust?

It’s vital for people who want to use a trust to take the time to think about why a particular structure is being used and how it will be used.

They’re not a “quick fix” to asset protection and taxation issues. Rather, they’re a way to provide flexibility and need to be properly established and administered.

These are the common issues arising from the improper use of trust structures:

• the failure to make and properly minute distributions before 30 June, which can result in paying tax at the highest marginal rate
• the failure to properly deal with succession planning of the appointor role
• the failure to appropriately deal with loan accounts and unpaid present entitlements
• improperly amending trust deeds, resulting in duty and capital gains tax implications
• poorly drafted definitions of beneficiaries, which can result in the trust being deemed to be a foreign trust for duty and land tax purposes

There is also the ongoing possibility of legislative change to the taxation treatment of trusts. Depending on the extent and nature of any changes, however, it is likely that discretionary trusts will still retain significant asset protection and estate planning advantages.

Using a trust for property investment is not always a perfect solution as each scenario is different and can present both advantages and disadvantages. What is most important is that you understand what your goals are for your property investment and the long-term implications that come with it.

You don’t want to be in a situation where you’re changing structures in the future as that could 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.

Disclaimer
We are not a financial advisor therefore please consult a professional investment adviser before making any investment decisions. This blog is not financial advice.