When purchasing property, there are three main factors to take into consideration when determining the most appropriate ownership structure. The three main factors are Estate Planning, Asset Protection and Tax Planning.
Estate Planning is the process of arranging the transfer of individual’s assets to the preferred beneficiaries upon death or incapacitation. Asset protection is safeguarding one’s wealth against those who may have claims against it, such as creditors, former spouse, customers/clients or tenants.
Tax Planning involves structuring all other elements of a financial plan in the most tax-efficient manner possible.
Trusts – Advantages
There are many different types of trusts and the type of trust you choose depends on the type of investment, gearing, and whether you are in a business structure or an employee. Generally however, the advantages of trusts are as follows:
- Provide better asset protection, for example, should a beneficiary become bankrupt or sued, the assets held in the trust are not at risk. Provided the assets were held in the trust before any bankruptcy clawback timeframes and the trustee is structured appropriately, then trusts provide better asset protection.
- Flexibility in tax planning, for example, trusts generally allow the income to be determined and paid to different beneficiaries annually which can provide tax effectiveness.
- Cost effective, set up and annual compliance costs are relatively cost effective compared to the overall benefits that a trust structure can provide
- Flexibility with retirement and succession planning, for example, you can pass on control of the assets to your beneficiaries whilst you are still alive without any Capital Gains Tax Consequences (CGT) or Stamp Duty consequences.
- Access to the 50% CGT discount concession is available to assets sold by the trust for a capital gain provided that the asset is held for a period of more than 12 months
- Land Tax Grouping provisions do not apply with Trusts
Trusts – Disadvantages
- Rental and tax losses are quarantined and cannot be offset against the individual beneficiaries income if the trust is claiming the interest on the loan as an income tax deduction (certain exceptions apply for negative gearing with trusts, however, each individual and taxpayer group is different and specific circumstances need to be taken into consideration for effectively utilising tax losses via trusts)
- Same applies to capital losses
- If you already own property in your own individual name and wish to transfer to a trust structure, transfer costs such as CGT, legal fees, accounting fees and Stamp Duty are usually very cost prohibitive
- In most states of Australia, annual Land Tax costs are higher for properties held in Trusts as opposed to individual ownership
- If your principal place of residence is owned by a Trust then you do not qualify for the tax free CGT exemption when you sell the house.
- Annual compliance and accounting costs are usually slightly higher than individual ownership
Individual ownership – Advantages
- If the property is an investment property, available for rent and also used for income producing purposes then the annual rental losses can be offset against your other individual taxable income.
- If the property is your principal place of residence the tax free CGT exemptions are available as are things such as the six year rule and the indefinite CGT free exemption if the property is not used for income producing purposes (of course, all subject to specific criteria being satisfied)
- Simple structure without complexities
- Land tax in most Australian states is cheaper
- Access to the 50% CGT discount concession is also available for individuals to assets sold by the trust for a capital gain provided that the asset is held for a period of more than 12 months
- Ongoing accounting and compliance requirements and costs are generally cheaper than trusts
Individual ownership – Disadvantages
- Land Tax Grouping provisions apply if multiple properties are owned by the same individual(s) therefore resulting in a larger annual Land Tax payment
- No asset protection available (especially for individuals with high-risk occupations, high net worth of assets and/or are in business), however, this can be rectified with an Equity Mortgage Trust and increasing the level of debt on the properties as well. Ultimately, you can still have superior asset protection for assets held in individual names without triggering CGT or Stamp Duty and your accountant should be able to assist you with this.
- Estate and succession planning is very limited and can be cost prohibitive, for example, if you own properties in your own individual name and you wish to transfer/gift the property to your beneficiaries while you are alive, this will attract CGT and Stamp Duty which are cost prohibitive. Effectively, you will need to pass away first if your beneficiaries are to inherit your properties tax free. However, you may live for a long time (we are living longer nowadays) which may not be ideal for all parties. However, one way to negate this (if you wish to provide your beneficiaries with a head start in life) is to either be Guarantor for their loan and/or provide your property(ies) as security for their loan.
- Even if your beneficiaries inherit your properties tax free, the risk of lack of asset protection merely just transfers to them (especially if they are in high-risk occupations and/or are involved in their own family asset group structures) so therefore the beneficiaries are exposed. However, one way to negate this conundrum is to have a Testamentary Trust inherit the wealth and your beneficiaries control this.
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