A trust is one form of holding property. It is easy to assume holding property in your own name gives you the most control, but a trust could protect you and your assets in case of unexpected financial pressure.
Blogger: Cam McLellan, director, OpenCorp
There are several types of trust. For a property portfolio, a standard discretionary family trust is suitable. A trust is an arrangement where property is held ‘in trust’ (by a trustee) for the beneﬁt of others (the beneﬁciaries). There are two ways to hold property: in your own name or in a trust (which means the property is held ‘in trust’ and you control the trust). It may sound complicated, but this form of control has advantages. Also, trusts aren't as complex as they seem once you understand the terms and laws that apply to them.
To understand trusts, we must travel back in time to look at where and why trusts came about. As far as I can tell, trusts were ﬁrst used around 400 BC when the Greek philosopher Plato set up a not-for-proﬁt trust to fund his university. The ﬁrst trusts to hold property were set up in England in the 11th century. By the 15th century, they were common.
Trusts were mainly used by landowners to protect their land from greedy lords and kings. Back when knights rode horses and swung swords, there were hundreds of taxes and limitations on what people could and couldn’t do with their land. If a king or lord found a landowner had committed a ‘crime’, they could throw him in jail (or worse) then seize his land and leave his family with nothing.
This was why smart landowners moved the ownership of their land to trusts, which meant they weren't bound by the same tax rules and limitations as individuals. More importantly, their land was protected. If they were found guilty of a crime or sent to war, the king or lord couldn't take the land because the trust owned the land, not the individual. Instead, the landowner’s family could assume control of the trust and the land. The land never changed hands, so there was no tax when it was transferred to the family or heir.
Should you use a trust?
Today we still have tax laws like in the old days. We also have a very real need to protect our assets.
Laws determine how trusts operate. And who makes our laws? Politicians. And how do politicians and rich people hold assets? Believe it or not, most use trusts. While there are no guarantees, there’s a good chance any law changes will favour trusts. There are a number of people and entities involved. I’ll describe each role.
These are the people a trust is designed to beneﬁt. If all proﬁt made by a trust went to one person, they could pay the highest tax rate. But because trust income is spread among beneﬁciaries, each person pays tax at their marginal rate. Spreading the income achieves the lowest overall tax rate.
The trust may pay tax on behalf of beneﬁciaries but retain after-tax funds for reinvestment and safekeeping. The tax advantage of a trust may not seem huge. But as years pass, proﬁts ﬂow. Why give money to the government when you can keep it in the family? There are a few types of beneﬁciary, but it’s usually someone related by blood or marriage. You can make a company a beneﬁciary and you or your family will own that company. If you distribute enough proﬁt to beneﬁciaries, you can put extra proﬁt into a beneﬁciary (‘dumping’ or ‘bucket’) company to be used later. Why? Because companies pay just 30 per cent tax. When beneﬁciary incomes exceed their tax bracket, they pay a higher rate.
A trustee can be one or more people or a company. A trustee manages the daily operations of the trust. I have several trust structures and use companies as my corporate trustees. As director of these companies, I maintain control.
To set up a trust, a settlor must give a small amount of money, to be held in trust. I normally use my accountant as settlor. I never use a family member, as a settlor can’t beneﬁt from a trust.
The appointor is the most important person in a trust. I sometimes refer to them as head honcho, big dog, kingpin, drill sergeant, big cheese, boss or chief. The appointor has the power to appoint or sack a trustee. Kids, it’s very important for you to be the appointor. When getting a trust set up, ensure you’re the appointor. If the person setting up the trust is unethical, they may name themselves as appointor. This means they can sack you as trustee and take control of your property. You’d instantly lose everything held in that trust. This is a very scary scenario, so always check your documents.
Advantages of trusts
- Control – You own nothing, but control everything.
- Asset protection – This is the most important thing a trust can offer. There are plenty of scumbags out there who’d start a lawsuit for a few easy bucks. Sadly, Australia is becoming more like the US in this regard. If someone tries to sue you, your ﬁrst move is to sack yourself or the company (because you’re the appointor) as trustee. With this is done, there’s no link for anyone to access the assets. And thus no reason to sue.
- Income distribution – You can distribute income across your family and pay a lower tax rate.
Disadvantages of trusts
- Loss of negative gearing – Negative gearing means you can offset losses and reduce your taxable income. This is seen as an advantage when you own a property in your name. With trusts, you don’t get this immediate tax beneﬁt. You can, however, carry these losses forward and offset them against future proﬁts. Initially you may buy the ﬁrst few properties in your name until you’ve built enough equity to cover holding costs. The small initial tax advantage of holding a property in your name is far outweighed by the distribution and transfer of control beneﬁts of holding property in a trust structure. You and your family will be better off in the long run by using trusts.
- Fees – Accounting fees are higher when everything is held in trust. Take into account that the set-up fees and yearly accounting fees will also be higher, because the tax return is slightly more complex.
- Borrowing – Finance is more complicated and you need a broker or relationship manager at the bank who understands trust lending. Most do these days. Get your structure right. If you buy multiple properties in your name, it’s like stacking lots of blocks and waiting for a bully to knock them over. You risk everything crashing down. You also risk paying huge tax bills at a later date. Always use a trust when investing.
Get your lawyer to prepare a legal will. Every ﬁnancial plan needs an exit strategy because sadly, we all take a ﬁnal bow. This is very important. If you have no legal will, your assets may be distributed against your wishes and this can get very messy. You built your portfolio, so make it clear who beneﬁts from all your hard work.
• Invest in a family trust.
• Understand the roles associated with trusts and their function.
Advantages of trusts
• Income distribution.
Disadvantages of trusts
• Tax losses are carried forward if held in a standard trust.
• Set-up and accounting fees.
About the Blogger
Director of OpenCorp, Cam McLellan is committed to sharing his passion and property investment knowledge with everyday Australians.
After thriving in the telecommunications, technology and recruitment sectors and making six BRW Lists in 8 years, alongside accomplished OpenCorp. entrepreneurs Matthew Lewison and Allister Lewison, founded OpenCorp. eight years ago.
Cam started investing in real estate at a young age and quickly mastered the art of building sustainable wealth. He has used the same wealth building strategy to develop a multi-million dollar business, sharing his knowledge and skill with ordinary Australians. Cam has personally bought, sold and developed numerous properties and has an extensive residential and commercial investment portfolio.