Purchasing properties through a family trust has become an increasingly popular consideration as part of an investment strategy because it can offer excellent tax benefits and asset protection.
When clients work with us looking for an effective investment structure, they usually think of family trusts as part of their options.
In our experience, you must have a clear understanding of what role a family trust plays in property investing.
There is a range of key considerations to consider before discussing vehicles for structuring investment ownership.
So, if you’re thinking of using a family trust as a vehicle to purchase your next property, here’s what you need to know.
What Is A Trust?
According to the Australian Tax Office (ATO), a trust is a legally recognised relationship that exists between the trustee and the trust beneficiaries.
In other words, the trustee holds assets in a trust to the benefit of the trust’s beneficiaries.
In contrast to individuals (natural persons) and companies (legal entities) who can sue and be sued in law, a trust is not an entity in its own right. The trust exists merely as the relationship between the legal owner (trustee) and beneficial owners (beneficiaries).
Any assets held in the trust are held in the name of the trustee.
What Types of Trusts Exist?
The four common trust structures include:
- Discretionary trusts (or non-fixed trusts): there is flexibility in the distribution of trust income and trust capital (for example, family trusts).
- Fixed trusts: the entitlements of beneficiaries are fixed, and the trustee doesn’t have the discretion to distribute trust income and capital as they see fit (for example, unit trusts).
- Class trusts: these are similar to discretionary trusts in that the trustee can distribute trust income and capital, but a fixed portion must be distributed to at least one group specified in the trust deed (for example, where two or more families invest in a single asset).
- Hybrid trusts: a hybrid trust exists where different entitlements are allocated to different beneficiaries. The trustee has the discretion to distribute the assets but must do so in accordance with each beneficiary’s entitlements (for example, one beneficiary may be entitled to trust income, while the other is entitled to trust capital).
While there are various types of trusts, property investors’ most popular trust structure is a family trust.
What Is A Family Trust?
A family trust is a type of discretionary trust set up to manage a family business or hold a family’s personal or business assets.
A family trust is discretionary in nature because the trustee is given complete discretion as to how the trust income and capital is distributed to the beneficiaries.
Using A Family Trust To Purchase Investment Property
Using a family trust as an ownership structure means that you won’t be the investment property’s legal owner but rather the beneficial owner.
This means that the trustee (which can be an individual or a company entity) will own the investment property on your behalf.
The main reason investors choose to use their family trust as a vehicle to purchase property is to create that separation between the asset owner and those who will benefit from it.
But what are the advantages of having that separation?
It’s because investors can set up their ownership structure for the purposes of:
- asset protection;
- tax planning; and
- estate planning purposes.
Family Trust Asset Protection
As the investment property is held in the trustee’s name, not your own, the property is protected from creditors if one of the beneficiaries goes bankrupt or is the subject of legal action.
This means creditors can’t use the property to settle any debt owed.
This does not mean that one should set out to defeat creditors and their rights.
Effective Tax Planning And Tax Benefits
The trustee of a family trust has the flexibility to distribute any income generated from the investment property as they see fit.
So, the trustee has the discretion to divide the income between the beneficiaries in the most tax-effective way each financial year.
For example, for beneficiaries of the family trust who fall under a lower marginal tax rate, the trustee can distribute more income to them as a method of reducing tax paid.
By dividing the income tax allocation, the trustee can effectively minimise the general tax obligations of the members who benefit from the income-generating property owned by the family trust.
Also, If the trust holds the investment property for more than 12 months, you can also take advantage of a 50% capital gains tax discount.
Estate Planning Purposes
A family trust deed prescribes exactly how the family trust will operate and each party’s role in the trust.
Effectively the control of the trust can be transferred without incurring capital gains tax or stamp duty.
Essentially, this should eliminate any legal disputes and simplify the transfer process.
Further Considerations When Structuring Investments In A Family Trust
Some other considerations that you should give when deciding on structuring property investments in trusts include:
- Retirement planning: you’ll want to make investment decisions to determine which structures will help maintain your desired lifestyle once you’ve retired.
- Family Succession: it’s been established that one of the main reasons for family trusts is to hold the family assets to pass the assets and wealth onto their children or other family members. So, due consideration should be given to how your family trust is structured to ensure that assets are transferred with ease and without leaving your children with the responsibility of covering excessive tax, stamp duty and other trust expenses.
- Cost: you’ll also have to consider whether the benefits exceed the costs of setting up and maintaining a family trust. It can be a costly exercise, and it must be worth the while if you want to benefit from this investment structure.
Are There Any Risks Associated With Purchasing Investment Property Through A Family Trust?
As with any investment strategy, no advantage comes without some kind of risk or downside.
It’s up to you (the investor) to consult a tax professional like Property Tax Specialists to help decide whether the advantages outweigh the risks concerning your personal circumstances.
Here are a few potential risks you should consider before using a family trust to purchase an investment property.
Negative Gearing Concessions Don’t Apply
If your investment property doesn’t generate enough income to cover the expenses that it incurs, then the property will be negatively geared. This means that your property is running at a loss.
A key benefit associated with a negatively geared investment property is that you can generally offset the loss against other income, e.g. salary. So, you can deduct the loss from your assessable income, resulting in a reduced taxable income.
However, if you purchase an investment property through a family trust, you can’t subtract these losses from your taxable income.
The loss will essentially get trapped inside the trust until the trust generates enough income to cover the cost of the loss.
Land Tax-Free Threshold May Not Apply
In some states, owning properties through a family trust means that your property may not be eligible for the tax-free land threshold.
For example, in New South Wales and Victoria, a family trust doesn’t qualify for a land tax-free threshold, so you might end up paying a high land tax amount. If you already own property in your name and are paying land tax, it may be beneficial to consider a trust structure for your next property purchase.
Transferring Individually Owned Property To Family Trust Attracts Stamp Duty
Suppose you’re considering transferring property you already own into the trust because of the mean benefits.
If that is the case, it’s worth noting the transfer process will attract stamp duty that the family trust will be liable to pay.
It’s also necessary to consider that you’ll likely have to pay capital gains tax as the individual transferring the property to the family trust.
A family trust is a structure that allows a person or other legal entity such as a company to hold assets to the benefit of others, known as the trust beneficiaries.
There are many benefits to purchasing an investment property through a family trust, such as effective tax planning and excellent asset protection strategies.
However, there are also several considerations you’ll need to take into account, such as the fact that a trust doesn’t allow you to deduct any losses from the taxable income. So if your investment property is negatively geared, the loss will essentially remain trapped in the trust.
While this article aims to give you a general overview of what’s involved in purchasing an investment property through a family trust, there is no “one size fits all” when it comes to family trusts.
The potential benefits and possible risks are entirely dependent on your individual circumstances.
To determine whether a family trust is a suitable option for you, it’s ideal to consult with a tax specialist or financial advisor for advice.
At Property Tax Specialists, our main focus is helping property investors maximise their opportunities and protection while legally minimising their tax liabilities.
To discuss any matter relating to structuring your rental investments, protecting your assets or arranging your affairs for minimum tax, get in touch today.
Please note that every effort has been made to ensure that the information provided in this guide is accurate. You should note, however, that the information is intended as a guide only, providing an overview of general information available to property buyers and investors. This guide is not intended to be an exhaustive source of information and should not be seen to constitute legal, tax or investment advice. You should, where necessary, seek your own advice for any legal, tax or investment issues raised in your affairs.
- PRO: AVOID PROBATE.
- PRO: SIMPLE AND FLEXIBLE.
- PRO: LIMIT ESTATE TAX EXPOSURE (AND OTHER TAX BENEFITS)
- PRO: AVOID LEGAL PROCEEDINGS.
- PRO: NO RISK TO PUBLIC BENEFITS ELIGIBILITY.
- CON: POTENTIAL LOSS OF CONTROL AND/OR LACK OF FLEXIBILITY.
- CON: COST.
- Protection Against Future Incapacity. ...
- It May Save Money on Estate Taxes. ...
- It Can Avoid Probate. ...
- Asset Protection. ...
- Trusts Can Cost More to Maintain. ...
- Your Other Assets Are Still Subject to Probate. ...
- Trusts Are Complex.
Family trust disadvantages
Any income earned by the trust that is not distributed is taxed at the top marginal tax rate. Distributions to minor children are taxed at up to 66% The trust cannot allocate tax losses to beneficiaries. There are costs involved for establishing and maintaining the trust.
Family trusts can also help manage taxation. In general, wealthier individuals stand to gain the largest tax benefits by creating a family trust. By moving assets into a qualifying trust, you may be able to avoid paying some or all of the estate tax due on your estate when you pass away.Is a family trust the best way to protect assets? ›
You have several options for protecting your assets for your loved ones. One of the most effective strategies for preserving your assets is to establish a family trust.What is the best structure for a family trust? ›
A Discretionary Trust is the most flexible form of business structure for a family trust. No single beneficiary has a fixed interest in the trust's property or the trust's income. The trustee has complete discretion in the distribution of funds to each beneficiary.What is the best trust to put property in? ›
An irrevocable trust offers your assets the most protection from creditors and lawsuits. Assets in an irrevocable trust aren't considered personal property. This means they're not included when the IRS values your estate to determine if taxes are owed.What kind of trust does Suze Orman recommend? ›
Suze Orman, the popular financial guru, goes so far as to say that “everyone” needs a revocable living trust.What is a trust and why are they bad? ›
A trust helps an estate avoid taxes and probate. It can protect assets from creditors and dictate the terms of inheritance for beneficiaries. The disadvantages of trusts are that they require time and money to create, and they cannot be easily revoked.What is the difference between a trust and a family trust? ›
A living trust can distribute assets to anyone who is named as a beneficiary when the grantor dies. Living trust beneficiaries can include family, friends, charities, alma maters, pets and others. By contrast, family trusts are designed to benefit only the family members of the grantor.
Trusts and companies both trap their losses. You can't pass losses in a trust or company to beneficiaries or shareholders the way you do in a partnership.Are trust funds worth it? ›
Trusts can offer financial protections, tax benefits, and even long term support to loved ones -- making them an invaluable tool in Estate Planning. That being said, Trusts have complex legal structures that can make them challenging to understand.Do I have to pay taxes on money received from a trust? ›
When trust beneficiaries receive distributions from the trust's principal balance, they don't have to pay taxes on this disbursement. The Internal Revenue Service (IRS) assumes this money was taxed before being placed into the trust. Gains on the trust are taxable as income to the beneficiary or the trust.Can you save taxes with a trust? ›
Irrevocable grantor trusts are generally seen as excellent tools for preserving family wealth. That's because grantors, as owners of the assets, must pay any taxes due on trust income. These payments reduce the value of the grantors' estates. That, in turn, eventually reduces the estate taxes due when the grantors die.What assets should not be in a trust? ›
- Qualified retirement accounts – 401ks, IRAs, 403(b)s, qualified annuities.
- Health saving accounts (HSAs)
- Medical saving accounts (MSAs)
- Uniform Transfers to Minors (UTMAs)
- Uniform Gifts to Minors (UGMAs)
- Life insurance.
- Motor vehicles.
The major disadvantages that are associated with trusts are their perceived irrevocability, the loss of control over assets that are put into trust and their costs.