Unit Trusts and the 2 methods of Borrowing

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/

 

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

 

@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!

 

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?

 

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

He makes the comment at the 32:50 mark

 

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!

 

Haha @Terry_w I know I know, was meant to acknowledge the 21st Century tie-in but forgot 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?

 

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.

 

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

 

I had an interesting scenario put to me earlier today.

Purchasing a property via a unit trust with a majority of units owned by two individuals and the remainder owned by their SMSF. There would be no borrowing against the property itself.

The individuals would then salary sacrifice aggressively to their SMSF. The SMSF would use this money to purchase more units from the individuals until all of the units are owned by the SMSF. Throughout the process the rental income from the property would be distributed based on the ownership of the units at the time of distribution. The SMSF share of rent would also be used to buy units.

This was presented as a way of purchasing a property via a SMSF when the individual doesn't have much money already in super, but has lots of cash in their personal name and wants to buy a property via their super (given the longer term tax advantages).

The recycling process in this case would likely take about 10 years and the property is likely to grow significantly in value over that time.

*** Would the units sold from the individuals to the trust be subject to CGT and Stamp Duties? ***

I kind of like the idea (if it works) for people who are personally fairly wealthy, but have little in their super - many self employed would fall into this category.

 

Yes this can work. Unit trust must comply with sis reg 13.22c including the trust property being unencumbered. But the non smsf unit holder could still borrow to acquire their units using other security.

Stamp duty would not apply in many states if the trust was not land rich.

Cgt event would occur on transfer of units.

 

Its no scheme. Its a legit strategy BUT made difficult with the reduce contributions cap of $25K per member per year, members age and more.

There are strategies that surround the deal that should be carefully considered:
1. Duty applies in QLD
2. CGT does apply to change of ownership but it can be spread over time and offsets the NEW personal deduction available for personal super contributions (why salary sacrifice I say !! - You can get a deduction at up to 47% v's a employer at 30%)
3. You dont transfer units in the trust !!! This is VERY important in some states.
4. Value of property and its state affects duty rules (ie QLD is a problem, NSW has a valuation cap)

And then there are other strategies for some property wealth people who have commercial property.
- CGT small business concession (doesnt count to NCC cap) and in some states there is a duty concession
- In specie transfer with a duty concession

Of course there are catches to all the above. One simple one is that trust should invest in NOTHING ELSE. Loads of property strategies exist. Its often worth asking ""can I"... I had an enquiry this morning to address $2m+ of property into super. Its NOT affected by the $540K non-concessional cap.

 

Hi Terry,

Method 2 that you explain - can you answer the following questions for me:
* is this strategy still legit as of June 2017 If so
* can individual parties gear to purchase units in the trust
* can an SMSF purchase units with/without gearing
* is there a limit on the number of investors for units in the trust
* is st George still doing these types of loans

Happy to make an appointment to understand more as I'm interested in pursuing this strategy amongst 7 friends who also have an SMSF. I've setup a unit trust with a corporate trustee.

 

1. yes
2. yes
3. yes/yes
4. yes - i think it has to be under 20
5. the last one I did was about 12 months ago, but I don't see why it wouldn't be possible.

If the SMSF will be a unit holder there is a whole lot more complexity. If the SMSF wants to borrow to acquire the units It is possible in theory, but you will have difficulty finding a lender willing to lend on this basis.

 

Hi Terry,

Thanks for this detailed post. I sent you an email as well and would be keen to have a chat and may be discuss how we can proceed? Thanks!

 

I have received no email from any one with a name similar to yours. I do get a lot of spam and often empty the spam folder without checking too closely so might have deleted it.

 

Related to this topic, I have worked out a strategy to have the trustee borrow from the bank yet the individual get the deduction. It is good for those who might be on a higher interest rate and are finding it difficult to refinance because of the fact that the borrower is not the owner of the property.

I have a positive private ruling from the ATO.

 

thanks for the reply, just sent it again.

 

PBR 1051550577493

 

Hi Terry, this is exactly what i am looking to do. Just wanted to clarify few questions if you would't mind answering:

Is this scenario (borrowing in individual name to buy units) still valid?

If i refinance my existing home loan to get $500k out of equity and then use this $500k to buy units in a fixed unit trust (4 friends buying a property under a unit trust), will i be able to claim the benefit of negative gearing against my other income?

Instead of using equity, if i want to get a new loan to buy units in the unit trust, now a days, which lender do this type of loan? Is St. George still doing this?

Thanks.