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Unit Trusts and the 2 methods of Borrowing

Discussion in 'Property Finance' started by Terry_w, 29th Dec, 2015.

  1. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Unit Trusts and the 2 methods of Borrowing

    A unit trust is a trust where the beneficiaries are unit holders entitled to fixed portions of capital and/or income of the trust. There are two ways that finance can be structured with the trustee of a Unit Trust owning the property.


    A. The Trustee Borrows to buy the property, or

    B. The Unit Holders borrow to buy the units of the Unit Trust


    Trust Borrowing

    Where the trust borrows to buy the property the interest and other costs incurred will be expenses of the trust. So any from negative gearing will fall into the hands of the trust. Trusts cannot distribute losses so the loss cannot be used to offset personal income of the unit holders for example. The losses will need to be carried forward to be offset by future incomes of the trust.


    Unit Holder borrowing

    Little understood but the individual unit holders can borrow to buy the units of the trust. The units will be income producing so the unit holder will be able to claim any interest on loans used to buy these units – but only if certain trust law requirements are met.


    The unit holder’s only expense in owing the units will be the interest on the loan. Without paying interest the trust will very likely make a profit and this profit can be distributed to the unit holders of the trust. If this income is less than the interest incurred then the unit holder will be able to claim the loss against their other income.


    This indirectly allows negative gearing in a trust. Losses cannot be distributed, but the loss is diverted to flow outside of the trust.


    You might ask how this works in practice as no lender is going to allow someone to borrow to buy ‘units’. It is difficult to get finance because it will be the trustee that is the legal owner of the property, but the loan in another name – the unit holder. Not many banks will lend to third party borrowers like this.


    The borrower will be the unit holder(s) with the company as trustee giving a guarantee and letting its property be used as security for the loan.


    One lender that is very good at these loans is St George.


    You must check loan documentation very carefully as even when the loan is approved on the basis of the borrower being the individual I have had cases where the lender documents have come out incorrectly. This could be due to the staff in the document preparation team thinking it is a mistake and fixing the mistake by swapping the borrower and the guarantors around.


    Example

    Tom sets up a Fixed Unit Trust with a company as trustee. He causes the trustee to purchase a property which will be negative geared. He realises he has 2 choices as to how to structure things (before he signs!).


    He does some figures

    $500,000 purchase price

    $350 per week rent, or $18,200 per year

    5% loan interest, or $25,000 per year

    20% of rent as expenses, $5,000 per year

    -
    Trust Borrows

    Income

    $18,200 from Rent


    Expenses

    $25,000 Interest

    $5,000 Other costs

    -------

    $30,000 in total

    Outcome

    $11,800 loss


    Tax Savings

    Nil. But loss can be carried forward (if certain requirements met) and can be used to offset future income
    -

    Unit Holder Borrows

    Income

    $18,200 from Rent


    Expenses

    $5,000 Other costs

    -------

    $13,200 in total

    Outcome

    $13,200 income of the trust

    This is then distributed to Tom

    Income of Tom

    $13,200

    Expenses of Tom

    $25,000 interest

    Outcome

    $13,000 income minus

    $25,000 expenses

    ------

    11,800 Loss

    Tax Savings

    Tom is earning a **** load of money and is on the top rate of 47%.

    $5,546 in savings in year 1


    Why would you want to structure the ownership of property under a unit trust? See https://propertychat.com.au/community/threads/legal-tip-17-the-18-advantages-of-using-a-ut-v-personal-name.969/
     
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  2. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Some more advantages with borrowing to acquire units in a unit trust:

    More advantages of borrowing as an individual rather than the trustee/trust being the borrower:
    1. Exemption from mortgage stamp duty [NSW]

    2. Individual can get professional package benefits (at least for St George Advantage package) but trustee/trust as borrower cannot.

    3. Don't have to sign document waving your rights under National Consumer Credit Protection code

    These ideas come from Mortgage Stamp Duty @myotherac
     
  3. House

    House Well-Known Member Premium Member

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    @Terry_w
    Was watching a video where the speaker said NG benefits can be claimed against PAYG in a trust. The trust is set up with the loan in the individuals name and title ends up in the trust. You then borrow the money from the trust so you get the tax benefits but also asset protection. Sounds similar to the above as being a Unit Trust but want to double check. Thanks!
     
  4. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Hi House

    If the trustee owns the property and the individual borrows to acquire units in the trust then, depending on the terms of the trust, the individual can claim the interest. This allows negative gearing in the person's name with the property in the trust.

    Not sure what you mean by borrowing money from the trust.

    Can you link the video?
     
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  5. House

    House Well-Known Member Premium Member

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    Always thought it wasn't possible but good to know the option could be available.

    He makes the comment at the 32:50 mark
     
  6. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    21st century!

    He just mentioned it in passing.

    He suggests and accountant for asset protection advice – which is legal advice.


    He says “you borrow the money back to the trust” which, for starters, doesn’t make grammatical sense. I think he means ‘lend’ the money back to the trust, i.e. the individual borrow money in their own name and then lend that money to the trust.


    This won’t work.


    For the individual to be able to claim the interest on a loan they would have to be borrowing with the ability to make income. If A borrows and lends to a discretionary trust the trustee may not give A any income, even if th trustee is a company solely controlled by A. So A could not claim the interest. No negative gearing would be possible.


    If A borrowed money and lent that money to a fixed unit trust A could claim the interest if A was the unit holder. This interest would be deductible as A is guaranteed to get any income (after expenses) as the trustee would have no discretion and all income would need to go to the unit holder.


    But this would not really allow negative gearing. A would only be able to claim the interest if A lent the money at the same or higher interest rate. This would mean the interest A paid the bank would be the same or lower than the interest A receives from the Trust. A would be neutral or making a profit – and profits are taxed!
     
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  7. House

    House Well-Known Member Premium Member

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    Haha @Terry_w I know I know, was meant to acknowledge the 21st Century tie-in but forgot :oops: wonder how they pass it through then. Must be something like that Chan and Nailher PIT™ Hybrid product they say the NG can also be claimed and get a refund.

    Thanks for the explanation, nice and clear as always :) is there any way to get NG benefits and claim the deductions in a trust without using the above mentioned companies?
     
  8. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    I think it was just a poorly worded statement with no intention to mean what he said - just an off the cuff remark that wasn't precise.
    The PIT is a fixed unit trust - nothing special except that they had trademarked the name (which makes the average person thinks it is a special set up).

    Trusts can negative gear like anyone, but just as you cannot claim my deductions, you cannot claim deductions incurred by a trust.
     
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  9. Paul@PFI

    Paul@PFI Tax Accounting + SMSF Business Member

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    A great example of why those who "suggest" things shouldnt be taken as advice. Its basically just terrible guidance and the sort of thing that if it even mentioned a SMSF would see ASIC breathing fire...But when its not a SMSF nobody cares.

    The PIT wasnt always a Fixed unit Trust. It was a hybrid for a long time and all the promised features were not there. It created angst for many who found that the ATO didnt like Hybrids. So it was amended to fix it. Not all PITs were amended however. So dont ever assume a PIT is a fixed trust.

    On the unit trust strategy there are additional ways and issues for borrowing beyond the 2 ways Terry suggested:

    3. Issue basic units to individuals ie 10 to Dad and 10 to Mum then the trustee borrows. Issue in this strategy is that loan does not result in neg gearing so positive trust income and trust claims interest so that the net income is shared in a fixed manner. Later when +ve gearing occurs units can be altered so say Mum is 100% unitholder. Benefit of this strategy avoid duty in some states. (Not QLD)and so % ownership can be changed later.. Perhaps using the refinance principle. Those who dont know refinance principle see ** below.

    4. Ungeared Unit trust strategy. When a SMSF wants a share of the trust !! Reg 13.22 of SIS permits a SMSF to have a trust interest provided the IP isnt used as loan security. Thinlk of it this way... Mum and Dad use borrowed $ from own home or other property to buy units in trust. SMSF contributes cash to buy units. Mum and Dads share of trust income and SMSF is all fixed. Mum and Dad claim a personal deduction against their trust income. They are neg geared perhaps. SMSF isnt.

    5. Mum and Dad etc lend to the trust on arms length terms (and register a mortgage).

    6. Dad lends to Mum to buy units in the trust

    7. Related party (company ? Another Trust) lends to Trust

    The key problem these days with unit trusts is the bank reluctance to lend to Mum and Dad and yet take security over the Trustee property. There are few lenders who play the game. This tends to "force" the trustee to borrow affecting neg gearing. Hence a neutral gearing is ideal to avoid accumulating losses in the trust.

    Otherwise if a strategy to increase trust income through say share investments etc works that could address the problem too.

    ** The Refinance Principle.
    Lets look at the issue of Mum owning 10 units and Dad owns 10 units. Property costs is say $100. (Borrowing from bank $80). Mum and Dad have a 50/50 beneficial interest in the trust. Now lets leap forward 10 years. Property is worth $400.

    Dad has a high income and wants to avoid the positive geared income. dad seeks to redeem his units. He redeems his 10 units (now worth $4 each). Mum borrows $40 and buys a further 10 units ($4 value). So she remains the 100% unitholder. But has extended her borrowing....Her loan is now $10+$40 = $50.
    The trustee received Mums $40 and pays Dad out. Dad uses the $40 to repay his share of the original loan he had of $10. He then uses the $30 and pays a littl;e CGT but still has $25 or so on hand. He uses that to repay his PPOR debt.

    So mum has used the refinance principle to
    - Increase deductible debt and
    - Help to convert deductible debt v's non-deductible debt

    Note I used low value examples...Imagine if in place of 10 units it was 100,000 etc
     
    Last edited: 21st Jul, 2016