There are three main type of property trusts a) unit trust b) discretionary or familty trust c) hybrid trust
Unit Trust – assets owned in the trust are split into portions known as “units”. The trust beneficiaries own these “units” in a similar way to shareholders owning shares in a company. Their share of the the income and expenses are proportionate to the number of “units” they own.
Discretionary Trust – most common type of trust for property investors. This trust is also known as a family trust and is usually set up to hold a family’s assets. The trustee has the discretion to distribute the trust’s income and assets to the beneficiaries depending on the beneficiaries situation to take advantage of the tax benefits.
Hybrid Trust – a combination of a unit trust and a discretionary trust. This structure allows beneficiaries to hold units in the trust and at the same time the trustee has the power to distribute the trust income according to the trustee discretion.
Advantages of buying property in a trust
- Asset protection – the investment property is held in the trustee’s name, and not on your own name. This is to avoid creditors from claiming the investment property when situation where one of the beneficiaries goes bankrupt.
- Tax benefits – Discretionary or Family trust allows trustee to distribute the income among beneficiaries in the most tax effective way each year. If the investment property is held by the trust for more than 12 months, you can tax advantage of the 50% CGT (capital gain tax) discount.
- Estate planning – a trust deed outlines the terms and conditions the trustee must follow upon the death of the trustee of what will happen to each beneficiary’s share of the trust’s assets. This results in not getting a probate which simplifies the estate planning process and avoiding conflicts and messy legal battles within families.
Important things to be aware when buying property using a trust
- If you individually own an investment property and you decide to transfer it into a trust, you will need to pay a stamp duty and you will be liable for CGT.
- If the trusts makes a capital loss or rental loss on an investment property, you don’t have the option to offset against other investment income. In other words, you lose the benefits of negative gearing.
- Choosing the right ownership struction of an investment property is complicated and can be confusing. Always consult an expert either an accountant or financial planner before you buy a property using a trust.
Property trusts confusion
Don’t confuse yourself with setting up a family or unit trust for investment property with professionally managed property trusts. These property funds allow investors to buy “units” in an investment property or multiple property which are managed by a professional investment management company.
Investors for these property managed funds trusts receive either dividends or income at fixed intervals.
Types of loans a trust can access
- Fixed rate home loan – fixed interest rate for a fixed period with limited extra repayments and offset accounts may also be available.
- Variable rate home loan – flexible interest rate that move up or down depending on market condition. The loan may be cheaper than a fixed home loan and usually offer additional features such as making extra repayments without penalty and an offset account.
- Basic home loan – affordable and easy to manage. It’s a simple loan with fewer features, waived application fee and low ongoing rate.
- Low Doc home loan – low documentation home loans are designed for self-employed borrowers who have fluctuating income and may have limited documented to prove their income. Signing an income declaration form allows you to access such home loan which may be of higher ongoing interest rate and fee.
How to compare home loans when borrowing through a trust
- Lender – you want a lender that understands how a trust works.
- Loan features – types of features should be determined by your financial needs and also the flexibility in making repayments or accessing funds. The more the features the higher the cost of the loan which may include offers such as offset account, extra repayments and redraw facility.
- Interest rate – shop around to get competitive loan interest such as whether fixed or variable interest rates.
- Repayments – a fixed rate mortgage repayment or a variable rate mortgage reapyment? Extra repayment flexibility?
- Fees – setting up a mortgage and a monthly account keeping fee
What banks look for for a trust loan?
- Types of trust – discretionary or unit or hybrid or SMSF
- Trust credit file – banks assess the credit file of directors, beneficiaries of a trust and the trustee company
- Trust deed – the trust deed confirms who the beneficiaries and the trustee are. The deed will be checked to make sure the trustee has the power to apply for loans for the trust.
- Loan structure – Usually the loan is in the name of the trustee or director of the trustee company rather than in the name of the trust. The director of the trustee company is the borrower while the trust is the mortgagor. This type of arrangement is to take advantage of the negative gearing benefits when using a unit or hybrid trust.
- Beneficiaries – sometimes the beneficiaries are required by the banks to be the guarantors for the trust loan.
Documents needed by the bank
- Certified copy of the stamped trust deed
- Certified copy of the company constitution (if there’s a company trustee)
- Identification for all trustees, directors of trustees and beneficiaries of the trust
- Tax returns and notices of assessment for the trust
Can the loan be in my name?
It is possible to setup the loan in the name of the trustee or director of the trustee instead of being in the name of the trust.
An example,
If James Mcguire is the director of XYZ Pty Ltd, the trustee for The Mcquire Unit Trust, the loan could be setup in two ways:
- Borrower: XYZ Pty Ltd as Trustee for The Mcquire Unit Trust
- Mortgagor/property ownership: XYZ Pty Ltd as Trustee for The Mcquire Unit Trust
- Guarantor: James Mcguire
- Borrower: James Mcguire
- Mortgagor/property ownership: XYZ Pty Ltd as Trustee for The Mcquire Unit Trust
- Guarantor: XYZ Pty Ltd as Trustee for The Mcquire Unit Trust
Can I sell my property to my trust?
You can sell your current investment property to your own trust. However, you will be subject to pay stamp duty and capital gains tax (CGT) for any capital gain you made since purchasing the investment property.
Trust Jargons
- Appointer: the appointer has the power to fire the trustee and appoint a new trustee. The appointer is specified in the trust deed.
- As Trustee For (ATF): this is a legal term meaning that the asset is owned by one entity as trustee for another or that the entity is acting as trustee.
- Beneficiary: the person(s) that receive benefits from the assets held in trust. This is generally in the form of trust distributions.
- Company constitution: if the trustee is a company then there’s a company constitution guiding how the company is to be run and what rules it must follow.
- Corporate trustee: a trustee that’s a company.
- Director of trustee: the director of the trustee company.
- Held in trust: assets owned by the trust on behalf of the beneficiaries.
- In Its Own Capacity (IIOC): a legal term meaning that a trustee is acting on behalf of itself. For example, a trustee may apply for a loan in the following name “ABC Pty Ltd IIOC & ATF The Smith Family Trust”.
- Individual trustee: a trustee that’s a natural person, i.e. not a company.
- Settlor: the person who settles (opens) the trust by depositing the funds into it.
- Stamp duty: a fee paid to your state government when opening a trust.
- Trust deed: the legal document governing the operation of a trust. The trust deed names the trustee, beneficiaries, settlor and appointer and contains the rules that they must follow when dealing with the trust.
- Trust distributions: income or assets distributed from the trust to the beneficiaries.
- Trust registration: the act of stamping and registering the trust with the state government.
- Trust: a legal instrument used by one party (the trustee) to hold assets on behalf of another (the beneficiaries).
- Trustee: the person or company that runs the trust and manages the assets on behalf of the beneficiaries.
- Unit holder: the owner of units in a unit trust.
- Unit: a share of a unit trust which denotes entitlement to a share of the assets within that trust.