Positive cashflow Trust

Being an investor who has purchased several properties outside a trust structure I had the following idea.

Concept basis: Buy realestate for capital gain, buy managed funds for income.

Would it be a good idea to set up a "positive cashflow Trust" ? A trust for investing in shares and managed funds. A trust where all capital gains from the realestate portfolio and a cash win falls can be parked? My idea would not involve borrowing in the trust or negative gearing...only unencumbered investments. Income based.

Reason: protection of cash and shares built up, flexibility in distributions to efficiently taxed beneficaries. How easy is it to transfer personal money or money outside of a trust, into a trust ?

MJK

 

Hi MJK,

I've found that your idea of separating strategies in to different trusts has helped me to manage my portfolio . Don't forget that you have to distribute all the income in the trust. I created my cash flow trust with a corporate beneficiary to help me manage this part of it.

Cheers, Medine.

 

Hi MJK

From a purely tax perspective it's best to have the borrowing in your own name if you're the highest income earner. Even though the assets are in your name, provided you keep the properties absolutely geared to the hilt, regularly redrawing the equity when available, then you have a kind of "de-facto" asset protection in relation to those properties. That's because after your bank has taken its share and costs there's next to no equity left for another creditor to snaffle.

Equally, where a normal discretionary (aka family) trust is used then it is best to stock that with cashflow positive assets. That's because any losses are trapped in the trust and cannot be distributed out to the beneficiaries. DTs provide the best asset protection.

It's easy to get money into a discretionary trust. You can either gift it or loan it. But here's where it gets more complex. If the purpose of redrawing equity under say a line of credit is to gift it to your discretionary trust then I believe the tax deductibility of the interest will be lost as it is no longer being employed by you for an income producing purpose (although that's what the trustee will employ those funds for).

On the other hand if you loan it, then you need to earn a commercial rate of interest on that loan for the deductibility of the interest to be preserved...which kind of defeats the purpose here. Also your asset protection is weakened because the loan owing to you is an asset of yours which your bankruptcy trustee could call in against the trust.

Perhaps one structure to think about is to implement a hybrid discretionary trust. You would use the LOC drawdown to buy units in the trust which would entitle you to a proportion of the income. The trustee could then use that "seed" money as the deposit for its own margin loan and margin into shares/managed funds to say the same amount i.e. a 50% margin gearing ratio.

Then come distribution time, subject to the terms of the units, you could distribute half the income/capital generated from those share/fund investments to your low tax beneficiaries and the other half to you as unitholder. The net effect though is likely to be that your interest bill wipes out most/any tax on that distribution.

Just some thoughts to ponder. As always you should take proper legal, accounting and financial advice before taking out a loan or setting up any investment structure.

Nick - anything to add?

Cheers

 

Are trusts the necessary evil ?

Thanks Medine & Nigel for your replys.

To be clear, my property holdings are all in my own name and borrowing is at 80% LVR. My only protection is insurances and mortgages. I'm happy with that. As far as tax goes, I control the mix of gearing, rental income and "on paper deductions" so that I pay very little tax and again I'm comfortable with that.

The trust would be to protect cash recieved from capital gains and other cash win falls. I would invest the unencumbered (not borrowed) cash into managed funds via the trust and distribute all income as required to various benificeries. Each time I sold a property, made a profit, recieved a distribution ar a tax refund I would keep this unencumbered cash in the trust in the form of more fund units, therefore protecting the hard earned $$$ from the property portfolio in my name.

What I'm trying to determine is, if I sell a property, should just buy managed funds in my own name or should I set up a structure? I really dont like the over complication of my structure (or lack off) but wondered what others think about my musings. I find the idea of trusts expensive and inflexible in that the type of trust can't easily be changed if later on it needs to be, but cant help feeling I'm investing irresponsibly without a proper trust structure.

MJK

 

MJK

No no no! Discretionary and Hybrid Discretionary Trusts aren't inflexible, they're the most flexible method of owning cashflow positive assets you can have!

If you were to set up a HDT you can just run it from day 1 like a pure discretionary trust. Whilst you would have the ability to issue units should you choose to, you need not do so straight away, or indeed at all.

This flexibility comes because a discretionary trust will let you stream income in different proportions each year to take advantage of different income and thus tax levels each year...

For example, for those that will have kids who go to uni full time, DTs are particularly useful to support your adult children whilst saving tax...

There's certainly a cost associated with using trusts, and some added complexity, but the tax benefits alone should make it ultimately worthwhile in the long term even without considering the asset protection benefits. Bear in mind also that increased land tax costs will not be an issue if you're going to keep your property in your own name.

as the ad says "please REconsider"...

Cheers

 

Usually I look at the idea of trusts from a asset protection point of veiw. Would there be any significant benifit in the model I put forward on this aspect?

With regards to land Tax I feel it can be adequately managed buy spreading investment around the country. Most of my property is in Qld where land tax in my opinion is quite reasonable. Last year I paid around 3K in Queensland but I believe due to cuts it will be significantly less next year, almost negligable.

I don't mind paying a bit of tax if I have to. It means I can justify buying another property with good depreciation benifits. I suppose managed fund investments are fairly liquid and could be cashed up and put into a trust down the track if necessary. But protection. What about asset protection?

MJK

 

Medine,

How does the corporate benificery thing work ?

What sorts of investments do you have in your +CF trust?

Do you run multiple trusts and what sort of investments are in these?

MJK

 

MJK
A HDT can operate with positive geared investments and neg geared property.

It enables you to stream the neg gearing to the high income earner by issuing them with income units.

If you borrow for the +geared investment then you would treat that as a loan to the trust. This would then be streamed through to lower income beneficiaries.

No need for multiple trusts if you use a HDT.

Cheers
Nickm

 

Hi MJK,

I do my share trading in this trust, and own one property that I was going to trade before the market went flat in Melbourne .

My corporate beneficiary can receive income from the trust, just like a person does, but it only pays 30 cents in the dollar in taxes, so it's handy to reduce tax.

I do run more than one trust, because I have separated my buy and hold from my trading. If there's only one interested party, I can't really see the point to having multiple trusts, and agree with Nick M's suggestion. But like the way I have things set up, all the same .

Don't forget that the set up costs are only the beginning. Each year a trust costs extra fees for accounting and tax returns.

Cheers, Medine

 

Hi Nick, for positive cashflow investments is there any advantage in having the loan in your own name and loaning it to the HDT as opposed to taking out a loan within the trust?

From what I remember from Chris Batten's notes on Investment Structures, and I may be wrong, was that you would only have the loan in your own name (and buy income units) while the investment was negatively geared. I was under the impression that once the cashflow turned positive it was best to re-finance and move the loan into the trust.

Any reasons for that?

 

I was wondering a similar thing. If you take out a loan, and then loan the money to the trust I thought you wouldn't be able to claim the interest as a deduction, as you are not purchasing an income producing asset. Is that right?

John.

 

I have read that if such a loan was on "commerical basis" then the trust would have to pay interest to you and hence your deduction for use of LOC funds would be deducable. BUT Try as I may, nobody has yet to describe what such a loan would be ..... Full, solicitor written thing I suspect, and at current rates of course.

 

Guys
Sim's example is correct.
A HDT works the same if you have a positive geared investment.

eg borrow $100K lend to trust
Trust invests and generates 10K pa
Trust pays you $7K interest then you pay to bank
Nil effect in your personal return
Trust has income of $3K

the result is the same under a HDT or a DT in this example.

To get a tax deduction for interest claimed when purchasing units in a HDT, the loan should be in your personal name as per Chris Battens notes.

NickM

 

Nick, in your above example where you say "Trust pays you $7K" how do you avoid that being classed as taxable income?

Again, in Nick's example, the trust has $3K to distribute. If I have units in the HDT which I purchased to set up a -ve geared investment, does the trust also have to distribute the $3K to me from this CF+ investment (assuming I'm the only one holding income units in the HDT), or can it be distributed to other beneficiaries like a normal DT?

John.

 

The ATO have the view that it is income, however you get a deduction for the interest paid. Nil effect

Yes it can. This is what i call quarantining negaitve gearing losses.
You can distribute the +ve cashflow to discretionary beneficiaries.

Nick M

 

Nick,

In order to quarantine the negative gearing losses do you need anything special set up, or do I just need to keep my records straight, ie, know exactly the cash flows for each investment as opposed to an aggregate position for the trust?

John.

 

Nick, also in response to your example....

Instead of borrowing $100K in your own name, wouldn't it be better to do it this way (where possible):

eg trust borrows $100k
Trust invests and generates $10k pa
Trust pays $7K interest to the bank
Trust pays you $3K distribution

I'd imagine this would be the preferred method if you take asset protection etc into consideration?

 

John, first thing you should do is check your deed. If it is a MGS deed then you should be fine.

Keep your records very straight, particularly matching your loan amount to the units purchased.
the rest is just accounting
NickM