What to consider when buying property in a trust

In Australia, a trust is not a separate legal entity but a relationship where a person or company (the trustee) holds assets on behalf of others (the beneficiaries). Trusts, especially family trusts, are often used for tax planning, asset protection, and estate planning.

Most family trusts for property investment purposes are discretionary trusts, giving the trustee control over how income, such as rental income or proceeds from the sale of a property, is distributed to beneficiaries.

Investing in property through a family trust can offer advantages like tax benefits, asset protection, and flexible income distribution. However, it may also come with challenges, including setup and maintenance costs, limited tax concessions, and complex loan requirements. Understanding these pros and cons can help you make an informed decision.

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A trust is a legally recognised relationship where a trustee holds and manages assets, such as property or shares, on behalf of beneficiaries. It is mandatory for trusts to be registered with the Australian Taxation Office (ATO) and lodge tax returns.

The trustee manages the trust’s property according to the terms outlined in the trust deed, which is a legal document specifying how the trust operates. Beneficiaries can be individuals, families, or companies. Any income generated by the trust’s assets is distributed to beneficiaries, who are then taxed at their applicable rates. A trust fund is the collection of all assets held within the trust, including property, shares, and other investments.

A family trust is often used by investors to purchase property, providing benefits such as tax planning, asset protection, and streamlined estate management. Depending on your financial goals and circumstances, buying property through a family trust may help you:

• Reduce tax liability: By distributing income from the property to beneficiaries in lower tax brackets.
• Protect assets: Shield assets from potential creditors or liabilities.
• Simplify estate planning: Use the trust deed to specify how property is managed or transferred in the event of a member's death or disability.

However, there are several legal, financial, and administrative responsibilities involved in setting up and maintaining a family trust. These include meeting regulatory requirements, managing ongoing costs, and ensuring compliance with tax laws.

Pros:

As an investor, there could be some potential benefits to buying property through a trust. These include:

• Tax benefits

A family trust can help reduce your tax liability by allowing income generated from property, such as rental income or capital gains, to be distributed to multiple beneficiaries. For example, if you have a high income and are in a higher tax bracket, you can distribute income to family members in lower tax brackets. This means the beneficiaries will pay tax at their marginal rates, potentially saving the family money overall.

• Asset protection

Property owned by a family trust is considered separate from your personal assets. This structure can help shield the property from creditors if you or any beneficiaries face financial difficulties or bankruptcy. Since the trustee technically owns the property, it may be harder for creditors to claim it as part of any debt recovery process.

• Estate planning

A family trust simplifies estate planning by allowing you to outline in the trust deed how assets, such as property, should be managed or distributed upon a beneficiary’s death or disability.

• Transfer of ownership

Within a family trust, property ownership can be transferred between beneficiaries without incurring CGT or stamp duty (as long as the transfer remains within the trust). 

Cons

Despite the benefits, consider the potential drawbacks before deciding on whether to set up a family trust for property investment.

• Stamp duty and capital gains tax

If you transfer an existing property you own into a family trust, you may need to pay stamp duty on the property’s value and capital gains tax (CGT) on any increase in value since you first purchased it.

• No negative gearing

Investors commonly use negative gearing to claim tax deductions when property expenses exceed rental income, reducing their taxable income. However, family trusts do not allow beneficiaries to offset losses against their personal taxable income.

• Higher setup and maintenance costs

Establishing a family trust requires professional assistance, such as from a solicitor or accountant, which comes with fees. These include drafting the trust deed, registering the trust, and ensuring compliance with tax regulations.

In addition, ongoing maintenance requires accurate record-keeping and regular updates to ensure the trust meets its legal obligations, which can involve recurring administrative costs.

• Financing challenges

Obtaining a home loan for a property held in a family trust can be more complicated than a standard home loan. Most lenders require all trustees and beneficiaries to act as guarantors, adding extra paperwork and potentially increasing risk for those involved.

Additionally, some lenders may view trust loans as higher risk due to the complex legal structure, leading to higher interest rates and stricter borrowing conditions. You may find the borrowing limits capped at 70-80% of the property's value, depending on the lender.

• Tax on minor beneficiaries

While children under 18 can be beneficiaries in a family trust, they may need to pay tax on trust distributions.

Both family trusts and self-managed superannuation funds (SMSFs) can be used to purchase property in Australia, but they serve different purposes and come with unique benefits and limitations. A family trust is often used for managing family wealth and offers flexibility in income distribution. In contrast, an SMSF is strictly regulated and intended for retirement savings, with its property investments limited to generating income for the fund's members upon retirement.

A key difference lies in the use of the property. A property held in a family trust may be used personally under certain conditions (such as a holiday home). However, SMSF properties are strictly for investment purposes and cannot be occupied or used by fund members or their relatives. Taxation also differs; SMSF income is generally taxed at a concessional rate of 15%, while family trusts allow income to be distributed among beneficiaries at their respective marginal tax rates, potentially reducing the overall tax burden.

When it comes to financing, family trusts have fewer restrictions, though trust loans may come with higher interest rates and more complex application processes. SMSFs, however, are limited to borrowing under strict conditions through a Limited Recourse Borrowing Arrangement (LRBA), which can complicate the process further.

Choosing between a family trust and an SMSF depends on your financial goals, investment strategy, and willingness to navigate regulatory complexities. You may consider speaking to a mortgage broker to better understand your options and make an informed choice.