'Trust' is one of those financial terms that many consider too complex to try to understand.
Unlike derivatives or collaterised loan obligations though, the way trusts work is actually fairly straightforward and they can be hugely beneficial when used appropriately.
There are a few reasons Aussies might choose to use a family trust to buy property. Here's what to know if you're considering doing so.
Buying property through a family trust
What is a family trust?
A trust is a financial structure where someone, called a 'trustee', holds and manages assets on behalf of others, known as 'beneficiaries'. For tax purposes, a trust is its own entity. Although, legally, the trust just refers to the relationship between the trustee and the beneficiary.
Turning a trust into a family trust can provide a couple of extra tax concessions.
To do so, the trustee needs to make a valid 'family trust election'. This must identify the 'specified individual' whose 'family group' is taken into account for tax purposes. There are no extra rights or responsibilities on the 'specified individual' - in fact they don't even need to be a direct trustee or beneficiary. However, if any benefit from the trust is distributed outside of this family group, family trust distribution tax (FTDT) could apply.
A typical family trust might have a parent as trustee and the children as beneficiaries. In some cases though, the family may prefer to appoint a professional or trusted advisor to act as trustee.
Family trusts are typically discretionary, which means the trustee can choose how the trusts income and assets are distributed among the beneficiaries. The trust can borrow money and is able to buy property that is held in the name of the trust on behalf of the beneficiaries.
How to set up a family trust
Setting up a family trust involves several steps:
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Consult a professional: Engaging a lawyer or accountant experienced in trusts to help you set everything up is advisable. While trusts are reasonably straightforward, some of the legalities and tax stuff can be a bit complicated, so it can be well worth having a professional take care of it.
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Draft a trust deed: This legal document outlines the terms of the trust, including the trustee's powers and who the beneficiaries are. To make it a family trust, a 'family trust election' also needs to be lodged with the ATO.
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Settle the trust: This involves a nominal initial contribution, known as the 'settled sum', to make the trust operational.
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Register for an ABN and TFN: If the trust will generate income, it will need an Australian Business Number (ABN) and a Tax File Number (TFN).
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Open a bank account: You'll also need to set up a bank account in the name of the trust to handle financial transactions.
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Transfer assets to the trust: You might already have some assets you want to transfer from your own name to the trust. This might mean property, a business asset or even just cash. If you are transferring ownership of dutiable property, you might need to pay whatever your state's stamp duty tax is.
Benefits of using a family trust to buy property
There are three main reasons why you might use a family trust to buy property, or transfer property you already own to a trust:
Tax effective profit sharing
A significant advantage of family trusts is their ability to distribute income to beneficiaries tax-effectively.
Family trusts are normally discretionary, which means the trustee can choose how income from the trust is distributed to the beneficiaries.
Trustees can strategically allocate income to beneficiaries in lower tax brackets, potentially reducing the family's overall tax burden.
Asset protection
Family trusts can protect assets from creditors in the event of bankruptcy.
While a trust isn't treated as its own entity in a legal sense, it's the beneficiaries, rather than the trustee, that holds the 'beneficial ownership' of the asset. Therefore, if the trustee is declared bankrupt, creditors cannot claim assets held in a trust, since they're not considered part of the trustee's personal estate.
If a beneficiary is declared bankrupt, it's a bit more complicated. If the trust grants the beneficiary a fixed entitlement to a trust asset (or a percentage of), creditors may be able to claim it to satisfy the outstanding debts. However, in a discretionary trust the trustee can simply choose to not distribute trust assets to that beneficiary.
Estate Planning
A trust provides a unique structure for passing the family estate down from one generation to another without incurring any stamp duty or other similar expenses.
The trust deed that governs a trust clearly lays down what will happen to each beneficiary's share on their death.
This should mean no messy, Succession-esque struggles to claim family wealth after someone passes.
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Drawbacks of using a trust
There are also a couple of downsides to using a family trust, including:
No negative gearing
One of the main drawbacks to using a family trust is that negative gearing isn't possible within them.
That might be worth considering if you're using the trust to buy an investment property that you're expecting to run at a loss.
More complicated
Managing a family trust can be complicated, and can demand to a greater administrative burden compared to that of holding property as an individual.
Family trust home loans
Obtaining a home loan for a property held in a family trust can also be more challenging.
Lending to a trust is a bit more complicated than lending to an individual, which means not all lenders are willing to grant home loans to family trusts.
Those that do often impose stricter eligibility criteria and require more comprehensive documentation. Such documentation might include trust deeds, financial statements, and identification for all trustees and beneficiaries. Many lenders also require all adult beneficiaries to act as guarantors.
It can be helpful to seek out a lender well versed in dealing with trusts. This could mean finding a mortgage broker who might be more knowledgeable on where to look.
Is buying property through a family trust a good idea?
Buying the family home through a trust
Holding a family home in a trust can better secure it in the event of bankruptcy. However, it's less common, since the principal place of residence capital gains tax exemption might not apply.
Property investing with a family trust
For investment properties, family trusts offer more substantial tax benefits as well as stronger asset protection.
Tax efficiently distributing income can greatly reduce your family's overall tax burden. For example, the trustee could allocate earnings from the investment property to children, rather than to a parent who sits in a higher tax bracket.
However, a loss borne by the investment usually can't be offset against your personal income, so it's worth crunching the numbers to figure out if you'll end up ahead.
It's generally advisable to get professional advice before investing in property through a family trust. Financial advisors will be able to review whether a family trust suits you and can help set up a trust structured to your individual situation.
Photo by @nci on Unsplash.
Collections: Property Investment
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