Tax Tip 490: Declarations of Trust and Deductibility of Interest

Discussion in 'Accounting & Tax' started by Terry_w, 13th May, 2023.

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  1. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    What happens to the interest on a loan if a person has borrowed to buy property and later makes a declaration of trust saying they now hold that property in their capacity as trustee. Will it change the deductibility of interest?



    There are heaps of legal issues with doing this – which will won’t cover now, but make sure you seek legal advice before many any declaration of trust.





    Example



    Homer borrows $400,000 to buy a property in QLD. He later realises that land tax could have been saved had he owned the property as trustee of the Simpson Family Trust. He has sought legal advice on everything except for the deductibility of interest going forward.



    Homer’s loan is with ANZ. If he suddenly declares he holds the property as trustee of the discretionary trust, the Simpson Family Trust, can Homer claim the interest? If not can the trust claim the interest?



    As far as I know there has been no indication on the ATO’s stance on this.



    I am of the opinion the interest won’t be deductible to either Homer nor the trust.



    A trust is not a separate legal entity, but it is a separate entity for tax purposes. When Homer borrowed the money he was not acting as trustee. If he suddenly begins to be trustee without changes to the loan it can be argued that the ‘trust’ has not borrowed. Homer is not entitled to the income of the trust, as it is discretionary, so he cannot claim the interest either.



    A simple solution would be to just ‘sell’ the property to himself, under a contract, even though at law you cannot contract with yourself, and to borrow with a new lender and use that to pay out the old lender.



    Note that it is also likely going to be a breach of the loan and mortgage agreement with the existing lender if the mortgagor declares a trust over property that is mortgaged to the bank.
     
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