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Buying property through a family trust

Buying an investment property through a family trust allows you to split profits between family members and pass on ownership without stamp duty costs.

Family trusts are a common instrument used to invest in property. They can be an effective way to share profits among family members, as well as to minimise tax liability and protect a family's assets. If you wish to set up a trust you need a trust deed and an ABN. You should also consider getting legal advice when setting one up.

What is a family trust?

Trusts are essentially an arrangement used in investments and business. In the simplest terms, a trust places an obligation on a trustee to hold a property or asset and manage it on behalf of the beneficiaries.

A family trust is a way to structure finances that removes them from individual ownership and tax liability. It places assets in the care of a trustee, who manages the trust on behalf of its beneficiaries. Assets are transferred to the trust and owned by the trust. The trust appoints a trustee to administer the assets on behalf of the members. It is then up to the trustee to distribute any income derived from the trust to its beneficiaries.

Family trusts are usually discretionary trusts

There are different types of trusts, such as fixed trusts and class trusts, but most family trusts for property investment purposes are discretionary trusts. This form of trust gives the trustee control over how income from the trust (say, rental income or proceeds from the sale of a property) is distributed to the beneficiaries.

How do you use a family trust for property investment?

A small familyA family trust can be used to purchase property, which is then held by the trust for tax purposes. A trust can be used to split profits among family members while proving to be a tax-effective property investment structure.

The tax benefits of buying property in a trust are:

  • Flexible distribution of income. If there are 3 beneficiaries in a trust, they don't have to get equal shares. The trustee could distribute income between beneficiaries based on their income and marginal tax rates.
  • Protect assets from creditors. Because the property is owned by the trust rather than any of the individual beneficiaries, creditors cannot pursue it even in the event one or more of the beneficiaries declare bankruptcy.
  • Transferring ownership. Normally, when you transfer ownership of a property, say to a family member, there's stamp duty charged on the value of the property and capital gains tax as well. But inside a trust you can transfer ownership without these charges coming into play. This can save everyone tens of thousands of dollars.

As with other property ownership methods, if you hold a property in a trust for more than a year, the property is eligible for a 50% capital gains tax (CGT) discount upon sale.

How do you set up a family trust?

Setting up a family trust requires a few documents.

First, a trust deed is required. This document outlines the terms of the trust, governs how it is operated and how assets are administered.

Next, the trust beneficiaries will have to hold a meeting to formally accept the trust deed and the appointment of a trustee. Minutes from this meeting will be used to document each beneficiary's acceptance of the trust deed and trustee.

The next document required is a Memorandum of Wishes. This document outlines the way the beneficiaries wish the income and assets of the trust to be distributed, though this is ultimately the discretion of the trustee. This document can be updated as the needs or wishes of the trust's beneficiaries change.

Next, a sum of money must be placed in the trust by a person known as a settlor. The settlor is a person unrelated to the beneficiaries, and can be an accountant, financial adviser, solicitor or any other third party.

The trust must apply for an Australian Business Number (ABN) and establish a separate bank account. Finally, the documents establishing the trust are filed and stamped by the relevant state government.

Are there any risks or downsides to investing via a family trust?

Property trusts take a bit of work to set up, and usually require the services of an expert, such as a solicitor or accountant. These experts charge fees, naturally.

There's also a bit of work to maintain the trust and keep accurate records of everything. But if the trust arrangement benefits everyone involved, the time and expense can be well worth it.

Negative gearing

Normally, property investors can claim tax deductions on investment expenses. If the cost of maintaining the property outweighs the income, the difference can be used to minimise your taxable income.

But family trusts do not allow beneficiaries to claim losses on their investment. This means family trusts do not benefit from negative gearing concessions. If your investment strategy relies in part on tax minimisation through negative gearing alone, you may lose out with a family trust.

Transferring ownership of property to a trust

Within a trust, transferring ownership lets you skip CGT and stamp duty. But if you set up a trust and then transfer ownership of a property currently owned by a single member of the trust, you will have to pay stamp duty and CGT.

What happens to a trust in the case of divorce?

Property in a family trust is off-limits to creditors, but it's not off-limits in a divorce settlement. Family courts can issue orders relating to the assets in a trust. This could result in the assets of a trust being divided up between spouses even when ownership of the trust belongs to an individual.

Keep in mind that how a trust is treated during divorce depends on many factors. This information is general information only and you should consult a legal professional when setting up a trust (and remember that your accountant may not be a qualified legal expert).

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