special report property investment structures

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s SpecialReport

Property Investment Structures

InvestorOne Pty LimitedGround Floor

Beanbah Chambers235 Macquarie StreetSYDNEY NSW 2000

[email protected] www.investorone.com.au

mailto:[email protected]


http://www.investorone.com.au/






SpecialReport PropertyInvestmentStructures

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Contents

Introduction 3

Problem with residential investment property 4

The way to avoid the problem 5

Hybrid discretionary trust/unit trust combo 6

Roy Morgan research 7

Who is the property owned by? 8

Did you get professional advice? 9

Were you aware of unit trust and superannuation? 10

Was the property to form part of your retirement? 11

Form of ownership and who advised 12

Ownership by age 13

Comparisons 14

Unit trusts 15

Borrowing with a unit trust (negative gearing) 16

Unit trust/hybrid discretionary trust combo 17

Unit trust/hybrid discretionary trust/superfund combo 18

Other material 19




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Introduction

This report looks at two alternative methods for the holding of residential rental

properties, which both provide the greatest amount of flexibility and tax-efficiency

and should be considered by every person looking to invest in property. For

years, many people have promoted the benefits of residential property investment.

Some will tell you it’s been the best investment of their lives , while others who

went to less scrupulous promoters, overpaid for their investment and, in some

cases, lost their homes. Generally, however, residential investment properties will

remain a staple diet for those people who want to build their wealth.

When considering the acquisition of any asset, it’s crucial to consider how the

asset is going to be held. That is to say, do you acquire it in your own name, in a

company, in a trust, or in a superannuation fund? The Government has decided to

partially reinstate the ability to combine superannuation, residential property and

debt. Yes, you can now use the funds in your self-managed superfund as a

deposit on a residential investment property. Up until 11 August 1999, many

people had used their super as a deposit on property in an arrangement that used

a unit trust. This was, however, outlawed, and effectively spelt the end of private

superannuation funds investing in residential real estate.

Although a new dawn is about to start with self-managed superfunds borrowing,

this will not apply to every person. For a whole range of reasons, people may still

elect to acquire assets, including residential rental properties, outside of the

superannuation environment. As will become apparent, many people (both prior

to 1999 and after) have acquired residential rental property in a way that limits

their options in the future.

This paper is not about self-managed superannuation funds borrowing to acquire

residential properties - that paper will be available early in 2008.




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Problem with residential investment property

Since 11 August 1999, when a change in the relevant law occurred, there has

been something different about residential property and other types of assets that

can be superannuation investments that have gone largely unnoticed. Unlike

listed shares, managed funds, listed property trusts, commercial property and

industrial property, residential property is prohibited from being transferred to a

person’s superannuation fund, if it’s owned by the person or a related party. The

legislation provides that if anyone breaches this prohibition, then the penalty is 12

months imprisonment.

What this means is that if a husband and wife, or either one of them, owns a

residential property in their own name(s), then they ’re prohibited from

transferring that property to their self-managed superfund for their retirement.

This is also the case if the residential property is owned by their company or

family trust. Since the introduction of the favorable concessions applying to

superannuation from July 2007 in what’s become known as Better Super, it ’ s

become very important to look at how your retirement assets are structured. This

is especially the case with residential investment property.

There are sound reasons for transferring assets to a self-managed superannuation

fund. In the past, many people have done so as a form of superannuation

contribution, in order to shelter their investment assets in a tax-friendly

environment with additional asset protection. Others have sold their assets to

their superannuation fund prior to their retirement, as a way of accessing their

super. Of course, post August 1999, these activities have been restricted to listed

securities and commercial and industrial property.




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The way to avoid the problem

The only way you can acquire a residential property outside of a superannuation

fund and later have its rents and any capital gains subject to taxation in a

superannuation fund, is to originally acquire the property in a unit trust. A unit

trust is a trust, the beneficiaries of which are known as unitholders. This is

because they hold units, which describe their rights to the income and capital of

the trust. The most common type of unit trust would have either a company or

mum and dad as its trustee, with mum and dad holding ordinary units which

entitle them to equal shares of the income and capital. More information about

unit trusts is available at the end of this paper.

If the unitholders in the unit trust approach a bank to borrow funds to buy their

units, and the property is acquired in the trust, then the tax and economic effects

of this arrangement are basically the same as if the unitholders owned the

property in their own name. The main difference is that the unitholders can either

redeem their units in the unit trust with a corresponding issue to a self-managed

superfund, or they can just sell their units to the superfund. There may be

income tax and/or stamp duty consequences for this transaction, and advice

should be sought before any action is undertaken. Holding a property in a unit

trust may also have land tax ramifications, with the laws in each state and

territory being different.

It is therefore important when considering any investment property purchase to

consider using a unit trust.




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Hybrid Discretionary Trust and Unit Trust combo

An arrangement where a property is acquired in a unit trust, and all the units in

that unit trust are issued to a hybrid discretionary trust, offers the greatest in

terms of asset protection, options, flexibility and tax-efficiency. Hybrid

discretionary trusts have many unique features and can cost more in both

administration and accounting fees, as well as incur greater liabilities to some

state/territory and federal taxes. Nevertheless, they should be considered by

every investor in property, whether it’s residential, commercial or industrial.

The hybrid discretionary trust and unit trust combo allows for negative-gearing bythe high income-earner in a family for a number of years. The units in the hybrid

discretionary trust that are owned by that person may be subsequently redeemed,

and then the income of the trust, including any realised capital gains, is able to be

distributed by the trustee on a discretionary basis. Of course, the refinancing

principle applies to the units issued by the hybrid discretionary trust. As the

property is acquired in a unit trust, a self-managed superfund could acquire units

at a later stage, subject to the satisfaction of certain conditions.

If the borrowing to acquire the units in the hybrid discretionary trust was secured

over assets other than the property in the unit trust , then, provided that the unit

trust has no borrowings, the superfund can acquire units in it. If the high income-

earner enters into a salary sacrifice arrangement so that some of their pre -tax pay

is contributed to their self-managed superannuation fund, then those funds can be

directed through the unit trust to the hybrid discretionary trust, and used to

redeem their units in the hybrid discretionary trust and pay down debt.




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Roy Morgan research

In a recent survey undertaken by Roy Morgan on behalf of InvestorOne Pty

Limited, only 1% of residential property investors surveyed held the property in a

unit trust. The results are surprising, considering the prohibition on a person

transferring their residential rental property to their super, unless its owned by a

unit trust. In addition, 78% of residential property investors surveyed stated that

they purchased the property as part of their retirement planning , and yet acquired

it in such a way that they can never transfer it to their superfund.

The research gives a real insight into the psyche of the residential property

investor and what motivates them to acquire a property. The survey also included

questions concerning where investors got advice, whether they knew of the

restrictions when a unit trust isn’t used, and whether they’d use a trust for their

next purchase. Again, the results were

surprising and reinforce the argument

that investors are not getting the right

advice or information concerning property

investment.

There has been a steady shift in the

methods by which property is held from

the traditional structure of the own name

of an individual to discretionary trusts.

However, the idea of using a unit trust to

involve a superfund has not really

filtered-through since the introduction of legislative changes in 1999. From this,

it’s obvious that investors and their advisors aren ’ t well informed when it comes to

structuring residential property investments.

Only 1% of residential

investment propertyowners selected the most

flexible and tax efficient

structure.




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Who is the property owned by?

Roy Morgan Research started the mentioned survey by asking who owns theproperty. This time, the results were startling - over 90% of all purchases were

made in individuals ’ names. Approximately 5% were held in discretionary and

family trusts and 2% were held in companies. Therefore, in excess of 98% of all

investors cannot transfer their property to their self-managed superfund!!




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Were you aware of unit trust and superannuation?

Over 63% of those who were surveyed weren’t aware of the ability to move a

residential investment property to a superannuation environment, if the property

had originally been acquired in a unit trust. Unfortunately, the majority of the

investors who sought advice from a professional just weren’t advised of the

options available to them. Obviously, the majority of those people that didn’t get

advice from anyone also acquired the property in their own name.




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Was the property to form part of your retirement?

More than 78% of all people interviewed indicated that the residential investment

property they’d acquired was to form part of their retirement assets. When you

consider the tax-free status of superannuation in certain cases and the ability to

enter salary sacrifice arrangements and pay-down debts very tax -efficiently, its

deeply concerning that that less than 1% of people acquired residential

investment properties in a unit trust, particularly when you have regard to the

long-term motives they had in doing so.




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Form of ownership and who advised

It’s fascinating to see the break-up of investment structures, based on who

provided the advice. The results show that accountants tend to favour family and

discretionary trusts as well as companies. Nobody that acquired their residential

investment property in a self-managed superfund was advised to do so by an

accountant or a financial planner, and nobody acquiring the property in a unit

trust received advice to do so from a solicitor.




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Comparisons

Individual as unitholder

Couple as unitholders

BANK

Smith Unit Trust

Smith Family Trust

Smith Pty Limited

Smith Unit Trust

SmithDiscretionary Trust

Trustee

Smith Unit Trust

Smith HybridDiscretionary Trust

The structures below WOULD

NOT allow for the investmentproperty to be transferred to a

self-managed superfund.

The structures below WOULD

allow for the investment propertyto be transferred to a self-

mana ed su erfund.

Own name - individual

Own name - couple

DiscretionaryTrust

Company

Trustee

Smith Unit Trust

Trustee

Trustee

Trustee

Trustee

Trustee




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Unit trusts

Trustee

Mr A – an ordinaryunitholder (entitled to aproportion of theincome and capital of the trust).

Mrs A – an ordinaryunitholder (entitled to aproportion of theincome and capital of the trust).

Unit Trust

Trustee The trustee can be mum or dad or mumand dad. Many people use a companywhich is an overkill if the trust is to holda passive asset like real estate.NOTE. The trustee and unitholdersshould not be identical.

Unitholders The unitholders are entitled to a fixedshare of income and capital equal totheir proportion of the units held.

Trust Deed The trust deed governsthe terms of the trustand the powers andresponsibilities of thetrustee and rights of unitholders.




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Borrowing with a unit trust (negative gearing)

Mrs A – an ordinary unitholder(entitled to a proportion of theincome and capital of the trust).

Money borrowed by Mr A would bedeductible to him, if it was used to purchaseordinary units giving him rights to receiveincome and realised capital gains.

BANK Mr A – an ordinary unitholder(entitled to a proportion of theincome and capital of thetrust).

TrusteeUnit Trust

Borrowing

Any borrowing to fund the purchase of an asset in a unit trust should beundertaken by the unitholder. In thiscase dad borrows to acquire his units toget the benefits of negative gearing.




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Unit trust/hybrid discretionary trust combo

Money borrowed by Mr A would bedeductible to him, if it was used to purchaseordinary units giving him rights to receive

income and realised capital gains.

Mr A – an income unitholder(entitled to a proportion of theincome only of the trust, whichwould include realised capitalains .

OrdinaryUnitholder

Hybrid DiscretionaryTrust

BANK

DiscretionaryBeneficiaries

Unit TrustTrustee

Trustee

Unit/hybrid combo The unit trust/hybrid discretionarytrust combination does provide themost flexibility and tax efficiency.The costs and complexity arenegatives to the structure andadvice should be sought beforeentering this type of arrangement.




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Unit trust/hybrid discretionary trust/superfund combo

Money borrowed by Mr A

would be deductible to him, if it was used to purchaseordinary units giving him rightsto receive income and realisedcapital gains.

Mr A – an income unitholder(entitled to a proportion of the income only of the trust,which would include realised

capital gains).

OrdinaryUnitholder

Hybrid FamilyTrust

BANK

Discretionary

Beneficiaries

SuperannuationFund

OrdinaryUnitholder

Superfund Members

Unit Trust

Trustee

TrusteesTrustee

Unit/hybrid/superfund combo Where the property acquired in

the unit trust won’t be used assecurity the superfund can beinvolved from the beginning eitherproviding a deposit or a salarysacrifice tax strategy.




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Other material

The following material will be available on www.investorone.com.au from 10

December 2007.

PDF Documents

Special report – Double taxation and unit trusts (Members only)

How to guide – How to set up a unit trust

How to guide – How to set up a superfund

How to guide – How to negative gear with a trust

How to guide – How to avoid poisoning property

How to guide – Tips and traps with unit trusts

How to guide – Moving residential property to super – the solution (members only)

Online videos

What is a trust?

Negative gearing with a trust

Why should I use a trust?

Hybrid discretionary trusts

Tips and traps with unit trusts

Residential investment property – the solution (members only)

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