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Legal Tip 113: Funding the Deposit for a new Trust Purchase of Property

Discussion in 'Legal Issues' started by Terry_w, 12th Jan, 2016.

  1. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    When a trust is settled the only assets are generally the initial settled sum which will be $10 to $50 generally. So how does a 'trust' buy property when it has no other assets?

    Trusts are just relationships, so it it is the trustee that buys the property, but the trustee does so with the money held on trust. If there is no money the trustee can borrow from a bank and generally there are no issues as the trustee's personal income is taken into account for servicing purposes. Where the trustee is a new company it will have no assets so the lenders will lend to the company with the director(s) and sometimes shareholders giving personal guarantees.

    The lenders won't generally care if the deposit money is coming from the individuals behind the trust or the trust itself, but there are important legal consequences to where the money for the deposit comes from.

    There are 2 broad choices:
    1. A gift, or
    2. A loan

    There is a 3rd option which is terrible, but seems to be the most common. The money of the person is simply used without consideration how.

    If money is gifted from A to B it becomes an asset of B. Therefore if the person being the trust gifts the money to the trust and later goes bankrupt the gift is no longer the person's asset. This will be subject to the clawback provisions of the conveyancing acts and the bankruptcy act, but gifting will allow for greater asset protection if the giftor later became bankrupt.

    Where money is loaned from A to B it remains the asset of A. So if the person loaned money to the trust and the person became bankrupt before this loan was repaid the trust will have to repay the creditors. There is less asset protection if the giftor become bankrupt. The property of the trust may be safe, but not the deposit.

    There are also tax issues.

    If A has spare cash laying around the lends it to the trust, the loan could be interest free or it could be at an interest rate. Where interest is paid by the trust to the person this will be income to the person, and may be a deduction to the trust. Generally this is the opposite of what people are trying to achieve which is the shifting of income to the trust and from there to the lower income tax paying beneficiaries. Therefore if cash is involved it may be better to lend interest free, or gift it to the trust.

    If A has a PPOR loan and cash in an offset account then lending or gifting this money to the trust would result in the interest on the home loan increasing and this interest would not be deductible.

    If A will be borrowing and on lending to the trust then there are more complex tax issues involved. I might cover this in a separate tax tip but generally the same or a higher interest rate should be charged to the trust, there needs to be a written loan agreement and the parties must follow the terms of that agreement.

    Simply using cash or a LOC to fund a trust without properly documenting things will result in loss of interest deductibility and adverse asset protection issues.

    Example
    Zhang has $100,000 LOC set up against his PPOR. He sets up a discretionary trust and he pays the deposit for the trust to purchase a new investment property. Because he has paid the deposit personally he has weakened the asset protection strength see
    Legal Tip 108: What is a Constructive Trust?
    Legal Tip 106: Resulting Trusts
    Zhang may stay solvent and this issue may not arise, but without a loan agreement the interest will not be deductible to either Zhang or the trust.
    Zhang may never be audited so he may get away with this.
    But say Zhang did end up bankrupt, there would be no evidence that this is a loan or a gift, so the creditors will argue it was a loan and claw it back.
    Zhang may die. His poor old family don't understand what went on. In his will he left everything he owned to the RSPCA who now sue the trustee of the trust to get the money back. His dad takes control of the trust and argues it was a gift - but there is no evidence. they spend $80,000 in legal fees over a $100,000 transaction...