Tax Tip 327: How a Negative Gearing in a Trust Can Reduce Personal Income

In ‘Tax Tip 325: Trusts Can Negative Gear’ I showed that trusts can negative gear, just like any other taxpayer can.

I also mentioned that it might be possible for a trust with a loss to reduce the income of an individual. This is done indirectly by diverting income to the trust with the loss so that income does not go to the individual, thereby saving that individual tax by reducing their income.

Example

Bart sets up a trust to hold a positively geared property. Let’s say it generates $10,000 per year in income after expenses. Bart is on the top marginal tax rate and the trust distributes this $10,000 to Bart who pays $4,700 in tax on it. He thinks it not wise to set up a bucket company just yet.

Bart goes out and sets up another trust to hold a second property. He does this for land tax (QLD) and asset protection reasons. It turns out the property was empty for a while as they couldn’t find tenants and its income was negative $10,000 for the year.

Bart causes Trust A to distribute to Trust B so that overall there is no income to go to Bart.

Bart has used trusts to indirectly negative gear and reduce his personal income thereby saving him personal income tax - $4,700 to be precise.



Note that there are lots of legal and tax issues with one trust distributing to another trust. Make sure you seek legal and tax advice before hand.



Example 2

Lisa is a single orphan with no family but investing through a trust which holds one property which generates $10,000 p.a. in income. The trustee distributes this income to Lisa and it increases the amount of tax she pays.

Lisa causes the trustee to acquire a second property which happens to be negative geared – the expenses exceed the income by $5,000 so there is a $5,000 loss on it.

The trust’s overall net income is $5,000 which goes to Lisa as a distribution. Lisa has lower income and saves tax as a result of the trustee buying the second property.

 

One common problem through this arrangement can be aggregation of land tax. So the trust now has two properties subject to land tax. Some poor solutions may suggest that a second trust be established for property 3. Same trustee company or different. Lenders may not like this arrangement since Trust A may be giving security to facilitate a loan to Trust B (same trustee) and lenders can perceive this as a breach of trust and may not be keen to do that. Grouping rules can also impact land tax - except for example QLD.

There can be limits to neg gearing trust properties. More so than individuals... that leads to a further practical solution

One other solution can be to allow the +ve geared trust to distribute. Then a beneficiary eg Lisa (now a adult) can borrow and neg gear a personally owned property so that her return includes positive trust income and a rental loss. This avoids the need for a second trust. May even spread land tax thresholds etc Lisa probably cant include the trust income is loan servicing calcs however since it is discretionary and not a fixed entitlement.