Structuring Case Study - comments??

Hi all,
I am going to present my thoughts from an analysis of my financial structures and how I intend to go about making them better - hopefully some less knowledgable than I (if there are any LOL) may get some benefit from the discussion and I also hope to get some critique of my analysis from those with a decent grasp of the concepts involved. I have very little experience in this area but have done my best to read all relevant books (very few available - eg Dale's books) and threads on Somersoft before making this post , so hopefully I will come across as at least partially compus on the subject.

I should make it clear that I am not after specific advice - more just comment on my thought process and/or identification of any generic/practical problems with the new structures I have suggested. I will be consulting with my accountant on the nitty gritty shortly

I will point out before I go on that I am not interested in setting up complex structures with transfer of property to superannuation. I'm only just past my 30th birthday and have no real interest in tying up assets. I should also say that asset protection and tax planning are both of great importance to me , but if I had to choose one structure over another where there there was a slight benefit to be gained in one direction or another , I'd take the best structure for tax planning as (all things being equal) I am not a huge liability risk (invest for a living)

My Current Financial Position

PPOR : Value approx 325k (owe 150k on simple P&I loan) = net equity of 175k

IP : Value approx 475k (owe 310k on IO loan) = net equity of 165k


Both properties are held in my name


Equities: A substantial - and unencumbered - portfolio of equities (worth more than the 2 properties put together) are held within a DFT with myself as appointor and trustee and a corporate beneficiary (a company set up for this purpose) . Any profits unable to be distributed to family members are passed to the company , which pays tax - after tax profits of the company will either be loaned back to the trust at commercial rates or (depending on legal advice) held "on trust" by the DFT. This setup is not to avoid tax (as I could quite simply trade within the company) but for increased flexibility and simplicity (one trading account). Either way the company will have to distribute profits as dividends etc..........if I wish to receive these funds later on,

Starting capital for the DFT was provided by myself and this therefore implies a loan from myself to the trust that is to be repaid to me at some time and is an asset of mine.

Possible Weaknesses Indentified


1) I am in a position to use equity from my property loans in my name to purchase further properties but do not have an appropriate trust structure set up within which to achieve this

2) within the next 12-18 months I intend capping my stockmarket equity and moving much of my trading profits from the DFT into property/property development. Purchasing this property within the DFT would be ideal in terms of offsetting trading income against property losses but may compromise asset protection by mixing low and medium risk asset classes - the property may be best kept in its own (new) trust

3) the DFT owes me in excess of $ 250k which is good in terms of providing access to tax free lifestyle funds for myself but also causes an asset protection weakness

4) I am in a financial position (given the money owed to be my the trust) to eliminate all non-deductible debt by paying off the loan on my PPOR , but have not done so as I do not wish to be without the funds in the DFT trading account for any period of time. It would be best perhaps to pay out this loan and replace it with an investment loan drawn against the paid out property.


Possible Solutions


a) create a new trust for property

Set up a new hybrid discretionary trust (HDT from here on) so that properties can be purchased tax effectively from equity drawn in my name. It will be set up with a corporate trustee (could be the beneficiary company of my DFT) After tax profits within the DFT could also be used to purchase income units in the HDT , thus allowing me to effectively move DFT profits into property.

I need to look further into the asset protetion situation in terms of the HDT. It appears the assets of the trust are at risk due to immunity offered to the trustee in many circumstances - is it compulsary that the trustee takes that immunity??? I also need to investigate the relevant clauses needed in the deed to make the income units as unattractive as possible to others ( giving trustee options regarding returning nominal capital at his discretion, only being able to redeem so many units pa unless at the trustees discretion etc.......)

b) DFT loan cancellation (gift)

Gifting the money would protect it from personal litigaton but would reduce access to tax free funds. I assume the process of gifting involves little more than a minute and having it reflected in the accounts of the trust as a liability cancelled.

The next idea would use much of this loan money anyway.............

c) Restructure personal property loans

The way I see it , I have a couple of options here and one much more complicated than the other , but perhaps worth a go.

i) simply refinance the properties to 80% LVR and use the equity released to buy units in the HDT. Refinance periodically to keep maximum gearing on the properties in my name. , OR

ii) simulataneously borrow $150k within the DFT and pay myself back $150k the DFT owes me - this will maintain my trading capital within the DFT. Use the $150k to pay out my PPOR P&I loan . Draw an IO investment loan/LOC against my PPOR and refinance the investment property loan as before. Use the available funds to purchase units in the HDT when a property opportunity arises.

In either case I would regularly revalue the properties in my name and extend the equity as available.




That's all folks!!!! I will be consulting one of Somersoft's resident mortgage brokers for advice on loan structures that provide maximum equity/flexibility with minimum cashflow drain etc........feel free to pick me to pieces


Cheers,

Ed.

.

 

Bon jour Ed

Currently O/s but will post my thoughts on return.

Au revoir

N.

 

Thanks Nigel - was starting to wonder if I'd just made such a mess of the topic that nobody was game enough to tell me

Cheers,

Ed.

 

Hi Ed,

Thanks for your long and interesting post! And congratulations on your achievements so far.

Your ideas on structure seem sound - particularly the parts where you said you'd consult some professionals. Maybe a financial planner could help, too?

Anyway, my question is about the part where you say "within the next 12-18 months I intend capping my stockmarket equity and moving much of my trading profits from the DFT into property/property development." If you're doing so well in the stock market why cap that success by capping the capital?

Cheers, Medine

 

Hi Medine - you asked for it ,
There are numerous reasons for that statement and it could almost be a topic in itself. The main reasons (in no particular order of importance) are as follows:

1) I always have favoured the stock market as an investment/income producing medium , but I have also always had a plan in the back of my mind to move profits into property once I'd reached a certain size for the "sleep at night" factor. I have done a reasonable job of building a substantial portfolio of investments and I am at the point where I am starting to look at ways of "future-proofing" this situation and making myself less vulnerable to a 1987 type situation on the markets, no matter how unlikely I think that is .

2) simple diversification

3) lack of leverage available in the stock market. This statement is not correct if you are talking bigger companies , in which case there are often some pretty decent margin lending LVRs available. I, however, tend to specialise in the small to mid caps where there is very little opportunity to gain any leverage . I tend to think of property in terms of return on the "deposit" (minus costs of ownership) rather than the 7% or so that we often see talked about in the media. Therefore if I can buy/develop good property with my stock market profits and get historical returns then this will represent a very good return on my capital with a huge supply of available investments. Unfortunately there is not a neverending list of stocks that will provide massive returns. Rather than go down the path of ever decreasing returns in the stock market , I'd rather buy into a relatively poor performing asset class like property (in raw terms) that provides the opportunity to leverage that to an acceptable return relative to my stockmarket activities and with a neverending supply of good investment opportunities available.


4) I am getting to the point , for a number of reasons , where my returns will start to diminish if I get too much bigger in terms of $$ invested. You're not going to get the sort of returns I target using blue chip shares and , given the poor liquidity in many of the small caps I trade, I can only go so big if I wish to have a chance of getting out when I need to. This means that currently I tend to have trouble buying more than say $10- 20k of any one stock in maybe 50% of cases and eventually I am going to be forced into the bigger stocks/longer term trading in order to get a meaningful position. With margin lending I should still do well but probably not as well.

5) Workload. I won't try and explain the intensity of the job I attempt to perform but I am already beyond the point to which most traders will push themselves. In a good market , like we've had these last few months , the biggest money is to be made actively "trading" the market. Because of the money I have invested and the relatively small position sizes involved (as mentioned above) I am often actively managing 40-50 positions or more simultaneously as well as reading all market news (hundreds of releases daily) etc.........and going too much further will likely send me loopy I am currently working say a 70 hour week when you take into account research, actual trading , system development work etc...........and I'm still way behind where I want to be. Moving some funds into property provides the basis for some passive income in the future when perhaps I want to reduce that workload a bit. Like most people who enjoy their job that may not happen when it really should though!

6) Additional Work: I have done some trading/investing on and off over the last few years for a colleague who is more a real estate investor. When I am active he will pay me a few bucks to pay the bills and a commission on profit. This hasn't really made a great difference to my finances so far , but I am told this is about to escalate dramatically in the next 12 months to the point where between the 2 of us I may be managing 2-3 million dollars. Managing his money (while providing me with some security of income and the ability to re-invest all profits , which will be nice) will also inevitably impact on the trading I do for myself. It will greatly increase the demands on my time via managing multiple accounts and - if we are both in the same stocks - will make it harder to get in and out of positions. If I am going to provide this fella with some decent returns and minimise the effect on myself , then moving some of my money into property makes some sense. And , at this stage , the security that this arrangement will provide is worth the trouble if I can invest my excess funds profitably elsewhere.


When you take all of the above into account I feel it makes sense for me to diversify into property. It's not going to be a simple case of moving all my profits into property. When the market is hot (assuming I am able to keep up) I will be more likely to retain profits in the market but, all things being equal, I will be starting to favour moving some $$ into property AS GOOD OPPORTUNITIES PRESENT.

I'm afraid the above doesn't read as smoothly as it might , but I didn't have time to draft sorry.

Cheers,


Ed.

 

Thanks, Ed.

Another amazing post

If your future property investing is this well thought out we'll be hearing about some great successes soon!

Cheers, Medine

 

Hi Ed

You're in a good position to move forward. My thoughts below.

You've noted that you'll get some advice from relevant experts but it's obvious from your post that you've already done a lot of reading and thinking about the best way forward - so well done.

I agree with this philosophy given your age. The tax benefits (and asset protection up to the RBL) of super is great...but the fact that the benefits are preserved within super and basically unavailable to you for several decades is to my mind just too great a disadvantage at your age and stage.

I'm with you on this one too if, as you say, your risk profile is actually low. Whilst the risks may not be too great, you're already a property owner - so that's an avenue of potential risk. Also, if you go down the development path - that's one which has led to the financial demise of plenty of people...so again asset protection is very relevant. See my further comments below.

Why not get rid of the non-deductible PPOR debt? You should be able to arrange with your bank so that the investment loan secured by the PPOR is available on the same day you repay the PPOR loan with the cash already in the DFT/Company.

You really need to have a look at the accounts for the trust and see how that money is recorded. Is their both an asset and a corresponding liability - in which case there's a loan? In my experience accountants will typically record the seeding of the trust as a loan because it makes sense from a tax perspective to do it that way...but if it truly was a gift (much better from an asset ptr perspective down the track) then the accounts should be corrected to reflect that.

Set up the structure - see comments below.

That's right, it does. Golden rule of asset protection...don't mix assets with different risk profiles within the same trust. Separation is key. Use a corporate trustee.

Start whittling this down.

As noted above this shouldn't be a logistical problem.

There are two issues here. Firstly, the trustee's right of indemnity out of the assets of the trust. Can you get out of it? No. So what this means is: if the trustee does wrong e.g. a development fails and the trustee owes ppl money they can step into the shoes of the trustee and access the trust assets to recover their loss. SO as noted above - (and I see you're aware of this danger) one shouldn't do a development with one's family trust with all one's shares in that trust!

The second issue is whether if you are successfully sued the units you hold are available to your creditors. Well the answer is technically yes. The units are an asset of themselves which entitles you to certain rights as against the trust (typically to receive income and be redeemed in certain circumstances). In practice though, I doubt they're of much actual value to the creditor...As far as I'm aware the issue is yet to be tested.

Process of gifting is quite straightforward. You could sign a "deed of gift", but the relevant minute noting receipt of the gifted funds (i.e. a loan forgiveness for the trust) is probably sufficient evidence.

We should probably clarify something here. The money isn't actually tax free if the trust owes it to you. It can only "owe" you the money if you've received each year the relevant trust distribution, duly paid tax on that distribution at your marginal tax rate for each financial year, then lent the money back to the trust to be used in the share investing. If you haven't received distributions and the trust has held onto the cash then the trust would have been taxed on this non-distributed trust income at the top marginal tax rate.

So it isn't tax free...you've just already paid the taxman...

(Of course what typically happens in practice is that the distribution does not actually involve any movement of funds. Rather the books of the trust reflect the distribution and re-contribution (by way of loan or gift) to the trust and you just record the distribution in your personal tax return and in the trust's return (but only you get taxed)).

The deductibility of trust borrowings to pay amounts to beneficiaries is an area of increasing scrutiny with the ATO. There's a (draft?) tax ruling about it (Nick will know this off the top of his head I'm sure )

Keeping properties held in personal names geared to the hilt is a cheap but effective asset protection strategy compared with moving them to a trust. Particularly if your risk profile is low.

Excellent post Ed. Thanks for taking the time to share your views and position to help others. I'm sure we've all learned something from it.

Okay, so what are some other ideas/observations to help Ed along?

 

Hi Nigel ,
Thanks a lot for taking the time to reply - it's confirmed a few things for me. Three quick points:

- the amount owed to me by the DFT is recorded as a "beneficiary entitlement" on the balance sheet which means , after distributions , that the net assets of the trust are the $10 used to start it.

- when I said "tax free" lifestyle funds that wasn't technically correct as you pointed out. I suppose I was saying that if it remained as a loan that could be paid back to me "tax free" (as it was already after tax funds prior to loaning it to the trust) it would be preferable to use these funds for a lifestyle purchase rather than perhaps taking a dividend from the company that may end up being taxed at 48.5c in the dollar in total . This is ofcourse just deferring the inevitable but the longer I can retain the money within the trust/company structure being taxed @ 30% then the better off I am.

- the loan taken by the DFT in my example- looking at things from my perspective - is a loan taken against the assets of the DFT to leverage my investing. It just happens that the DFT is then in a better position to pay me back some of what it owes me - it could easily be done right now without the DFT loan but I'd rather not. The two amounts (the loan and the repayment) need not be the same amount or occur at exactly the same time which may draw some attention. I see your point but feel I would be unlucky to be pulled up on this as there is certainly no ulterior motive here. I'd be interested in any clarification that Nick can provide.

Thanks once again Nigel.

Regards,

Ed.

 

Just a quick update and a question for Nigel.

I am in the process finally of paying off my non-deductible PPOR debt and taking a new loan in the DFT using the income from the DFT for servicing and offering up the properties in my name as security (90%) for the loan. Seems to make sense all round as I will now have all deductible debt , all interest only and personal assets geared to the hilt.

The one major weakness that appears to remain from an asset protection point of view (if someone was to dig deep enough) - other than my beneficiary loan account which I am working on - is the shares I own in my corporate beneficiary which is building up a load of cash at a rate of knots. This money has been loaned back to the trust at commercial rates but is there any benefit to be had by getting these shares into another name??

Cheers,

Ed

 

Hi Ed

So you're saying you own the shares in your company which itself owns a lot of cash?

If I understand you correctly then yes those shares (and thus the cash) are potentially exposed if you are personally sued.

One solution: sign a transfer form from you to your trustee under which you sell the shares to the trust. Again here is where it is conceptually easier to understand if you have a corporate trustee rather than you being trustee.

I think you're personally the trustee of your DFT. As such it's arguably more technically correct to say that what's involved is a declaration of trust.

Practically I suspect you should just sign a transfer form, get it stamped (you'll need a balance sheet), record the new shareholder in the register and forget about it. Note though then that dividends from your company will then go to the trust for distribution to the beneficiaries rather than to you directly...altho as a beneficiary you may still receive the money...

Cheers
N.

 

Thanks Nigel - you're right in that I am the trustee of my share trading trust. Any further trusts (which will relate to property) will definitely have corporate trustees ............ And yes much of the trust profit is at this stage finding its way to the corporate beneficiary which is flush with cash (that has been loaned back to the trust.)

I had considered the idea of the ownership of the corporate beneficiary being transferred to the trust and for some reason had let it slide - can't remember if I was told not to or not......I think I was just a bit worried it may look suss with the trust distributing to a beneficiary who then declares a dividend to the trust. But if that's okay then the idea of the company dividends going back to the trust and then being distributed from there seems to add further flexibility if anything as I can then move the company dividends to any trust beneficiary rather than just me as shareholder of the company.

On another tangent..........


The relationship between the trust and the corporate beneficiary has come up for discussion with my accountant a few times. I read a paper from 1999/2000 from a tax lawyer stating that the after tax trust distributions held by my company could be given back "on trust" the to trust. My accountant said no - if you are going to be giving the money back to the trust then it has to be via a loan on commercial terms.

Anyway -if it's a simple matter of signing a transfer form and it doesn't create any further issues then it seems the logical thing to do (the trust owning the corporate beneficiary). Now I am starting to wonder if there's any reason why I shouldn't do this transfer of company ownership to the trust and then as the company receives distributions and pays tax, just send the lot in dividends back to the trust rather than loaning the money?? The money just gets recycled rather than having loan agreements and interest flying everywhere.

Hope that makes sense



Cheers,

Ed

 

Hey Ed,

This question is a little off course but i thought i would ask anyway.

Your PPOR value (325K) seems low compared to the IP and all the equities that you own. Is this because you are happy with your current PPOR even though your financial situation has moved on since you purchased it, or is this a method for you to get ahead in other areas before you enjoy some of the returns.

Cheers

 

Hi Leandro - a bit of both I think.

I've just turned 32 and up til now I have worked on the theory of pay now , play later , which is fine as long as you live long enough So yes - I have from a young age had a longer term plan.

The other aspect to the story is that the area I live in is surprisingly affordable and does me just fine. The PPOR I estimate would go for 325-350k which is rather nice in a leafy suburb of Melbourne right on the Plenty River (the "green wedge") that is 30 mins from the city (out of peak hr) but only 2-3 mins from lovely rural property and maybe another 20-25 minutes to the Yarra Glen wine region. It is a 16 sq 4BR split level property on a 900 sqm block with lovely treed views. Until I outgrow the place with kids I'm quite happy here to be honest.

I have never felt the need to buy flash houses/cars for the sake of it and there's always the opportunity cost. I have only just yesterday purchased the first little reward for myself - a semi luxurious car around the 60k mark but even then the only reason I even considered that is because it's a lease and I can make the money that I'm not coughing up for a purchase work for me in the meantime.

So - just a little bit of "play" creeping into the outlook , but I still have a long way to go before I'll be looking at upsizing the house. Not when the stock market is ripe for the picking anyway

Cheers,

Ed

 

That's a great outlook to have Ed, well done on having your head screwed on

 

Hey Ed,

Perfectly understandable. Your PPOR sounds quite nice and I too would probably do the same in your situation.

I was just a little unsure as here in Sydney, a PPOR of that price range is not normally that crash hot. Unless maybe you are quite far away (much more than 30mins) from the city centre.

 

Excellent research

I must say that you did an excellent research on finance, but please do suggest how to manage my financial position in the coming years as the market hasn't overcome the pressure yet. but in current finance i can only manage to buy an old car

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