Question: I plan to buy my first property in Melbourne soon. I will live in this property for a minimum of six months, renovate it, and rent it out as an investment property. I’ve heard that borrowing via trust structures can be useful: What are the main pros and cons to using a discretionary family trust structure?
Answer: You have started on the right foot by putting thought into the legal structure. A trust is a relationship between a trustee and beneficiaries, where the trustee controls and deals with certain property for the benefit of the beneficiaries. Under a family trust, the beneficiaries are typically members of the same family and the trustee (which would be you or a company you control) has a broad power or discretion to decide which beneficiaries will benefit from the trust.
One advantage is that the trustee can to select the persons who receive the net rental income, which may allow you to reduce the total income tax payable. For example, if you have a spouse that is not earning taxable income, the trust could distribute the rental income to your spouse who may pay less tax than you if you received the income. Unless or until you are able and willing to distribute income to a spouse or another family member on a lower marginal tax rate, you will not get any tax benefits from a trust.
A family trust may also assist in protecting the equity in the property from potential creditors. If you have an exposure to personal liability, then you are better placed to protect the property if a claim is made against you personally.
During the time that you live in the property, the trust will be able to rent the property to you and offset the expenses (including interest) against the rental income. If you purchase the property in your own name, you will not be able to claim any expenses as a tax deduction until such time that the property is leased to a tenant.
You will also generally be able to take advantage of the small business concessions for capital gains tax in the same way as if you purchased the property in your own name. The trust can also take advantage of the 50% discount where the trust holds the property for more than 12 months. This means the net capital gain on which tax is paid is halved.
There are disadvantages, too. You will not be eligible to claim the first home owners grant, nor will you be able to claim the "principal place of residence" exemption from capital gains tax if you decide to live in the property and then sell it. If you intend to negatively gear the property to offset the interest against your other personal income, the trust will not enable you to do this.
A discretionary family trust is not suitable where you wish to invest with other people outside your immediate family group or introduce other investors down the track. Another form of trust, such as a unit trust, may be more suitable in this situation.
Finally, a trust will add some complexity and cost to your financial, tax and accounting affairs. You will need to engage an accountant experienced in trusts to advise you along the way.
Answer supplied by Terry Kokkinos, Macpherson+Kelley Lawyers (link: www.mk.com.au)
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