Trust Loans and Investing: Manage Wealth and Reduce Taxes

What Is a Trust? How Does It Work?

A trust is not a legal entity but rather a legal arrangement where one party holds assets on behalf of others. It’s a structure that separates legal ownership (the trustee) from beneficial ownership (the beneficiaries). Think of it as a relationship with clear rules about who’s in charge, who benefits, and how everything should be managed.

Key Roles in a Trust

A typical discretionary trust involves these parties:

Settlor

The person who establishes the trust. They contribute a small amount, often $10 or $100, to “settle” the trust. After this, they step back and don’t participate in managing or benefiting from the trust.

Trustee

The legal owner of the trust’s assets. The trustee (which can be an individual or a company) manages the trust, ensures its rules are followed, and acts in the best interests of the beneficiaries. For example, if the trust owns an investment property, the trustee collects rent, pays bills, and distributes income as outlined in the trust deed.

Appointor

A powerful role in the trust, the appointor can replace or remove the trustee. This ensures that control of the trust can be maintained even if issues arise with the trustee.

Beneficiaries

These are the people (or entities) who benefit from the trust’s income or assets. In a discretionary trust, beneficiaries don’t have fixed entitlements, as the trustee decides how much they receive.

What Does a Trust Hold?

Trusts hold “trust property.” This could be a house, shares, cash, or any other valuable asset. For example, if a family trust is set up to buy a rental property, the property becomes a trust asset. Any rent collected belongs to the trust, not the individual family members.

Types of Trusts

Choosing the right trust is the first step in property ownership. Each type serves different goals, so understanding your options is key. Here’s an overview of the main types of trusts in Australia, along with why they’re suitable for property investments:

Discretionary (Family) Trusts

The discretionary trust, commonly called a family trust, is the most popular choice for Australians investing in property. Here’s why:

• Flexibility: Trustees have the discretion to decide how income or capital is distributed to beneficiaries each year. This allows families to allocate rental income or sale profits to members in lower tax brackets, minimising the overall tax burden.
• Asset Protection: The trust owns the property, shielding it from personal liabilities like creditor claims against beneficiaries.
• Estate Planning: Discretionary trusts ensure that assets are passed on smoothly to the next generation, often without triggering stamp duty or significant capital gains tax.

Best for: Families wanting a tax-efficient way to hold and manage property while protecting it from financial risks. For example, a family trust could purchase a rental property, with rental income distributed annually to family members in lower tax brackets.

Unit Trusts

Unit trusts are ideal for group investments where ownership needs to be clearly divided. Here’s how they work:

• Defined Ownership: Assets are divided into units, like company shares. The share of income and capital each person receives depends on the number of units they own.
• Collaborative Investment: This structure is commonly used when multiple parties, such as friends, siblings, or business partners, invest together in property. It provides clarity and fairness in income distribution.

Best for: Investors pooling funds for joint property purchases. For example, a group of three friends could use a unit trust to purchase a commercial property, with income distributed according to their unit holdings.

Hybrid Trusts

A hybrid trust combines features of discretionary and unit trusts, offering both flexibility and fixed ownership. Here’s why it’s valuable:

• Dual Benefits: Beneficiaries can have fixed entitlements to capital (e.g., proportional ownership of the property) while also allowing the trustee discretion over how income is distributed.
• Tax and Ownership Flexibility: This setup can be useful for blending personal and investment goals, such as maintaining clear ownership while optimising tax distributions.

Best for: Investors who want the flexibility of income distribution while retaining fixed ownership entitlements. For example, a hybrid trust could be used for a family-owned property development project, where income from sales is distributed tax-effectively.

Class Trusts

Class trusts allocate specific rights to groups of beneficiaries, such as fixed portions of income or capital. These trusts are often used for multi-family investments or business partnerships.

• Targeted Allocation: Beneficiaries are grouped into classes, with each class having predefined entitlements. For example, one class might receive 70% of rental income while another class gets 30%.
• Control Over Complex Structures: This is useful when managing investments with multiple stakeholders who have different expectations.

Best for: Shared investments where parties want structured and predictable entitlements. For example, two families investing in a shared rental property could use a class trust to define how profits are distributed between them.

Self-Managed Super Funds (SMSFs)

SMSFs are designed for Australians who want greater control over their retirement savings. While SMSFs can hold property, strict rules apply:

• Investment Restrictions: SMSFs can invest in residential or commercial property, but the property must comply with superannuation laws (e.g., it can’t be used as a personal residence or rented to a family member).
• Tax Efficiency: SMSF properties enjoy lower tax rates on rental income and capital gains, making them ideal for retirement planning.

Best for: Australians planning for retirement who want property as part of their superannuation portfolio. For example, an SMSF might purchase a commercial property, with rental income contributing to members’ retirement funds.

Testamentary Trusts

This type of trust is set up in a will and starts after the creator’s death, often used to manage inheritance.

• Asset Protection for Beneficiaries: Testamentary trusts can shield inherited assets from beneficiaries’ creditors, divorce settlements, or legal claims.
• Tax-Effective Inheritance: Income generated by the trust can be distributed to beneficiaries at standard adult tax rates, even if the beneficiaries are minors.

Best for: Families wanting to protect property for future generations. For example, a parent could include a testamentary trust in their will to ensure that a family investment property remains secure for their children.

Talk to our experts to determine which trust suits your investment goals.

How to Buy a Property Through a Trust

Buying property through a trust loan involves a structured process. Here’s how it works:

Step 1: Setting Up the Trust

The first step is to establish the trust itself. This involves drafting a trust deed, which is a legally binding document that outlines:

• The purpose of the trust (e.g., holding investment property).
• The roles of key parties, including the trustee, beneficiaries, and appointor.
• The rules for managing and distributing the trust’s assets.

Most trusts are set up with the help of a professional, such as a lawyer or accountant. These experts ensure the trust deed complies with Australian law and meets your specific needs. For example:

• A discretionary (family) trust might be used to purchase a rental property, allowing the trustee to distribute rental income among family members in a tax-efficient way.
• A unit trust might be established for a group of friends pooling funds to buy a commercial property, ensuring each person’s share of ownership is clearly defined.

In some states, setting up a trust may require payment of stamp duty. For example, in New South Wales, stamp duty must be paid within three months of the trust’s creation if certain conditions apply.

Step 2: Securing Financing

Once the trust is established, the next step is securing financing for the property purchase. This is often referred to as a trust loan, as the loan is taken out in the name of the trust rather than an individual.

What’s different about a trust loan?

• Multiple Parties Involved: Most lenders require all trustees and beneficiaries to act as guarantors for the loan. This ensures accountability but also means more paperwork and legal obligations.
• Specialised Lenders: Not all banks or lenders offer loans for trusts. Those that do often handle them through their commercial or business banking divisions, which may have stricter lending criteria.
• Loan-to-Value Ratios (LVRs): Lenders typically view trust loans as higher risk, so they often cap the LVR at 70–80%. For example, if you’re buying a $500,000 property, you may need to contribute $100,000–$150,000 as a deposit.

When applying for a trust loan, the following documents are usually required:

• A certified copy of the trust deed.
• Trust-related paperwork may include financial statements and tax returns.
• Identification documents for all trustees and beneficiaries.
• The trust’s Tax File Number (TFN) or Australian Business Number (ABN), if applicable.

Working with a mortgage broker experienced in trust loans can streamline the process, ensuring you secure the most favourable terms.

Step 3: Finding the Right Property

With financing in place, the trust can begin searching for a suitable property. It’s essential to consider how the property aligns with the trust’s goals. For example:

• Investment Property: If the trust is buying a rental property, focus on areas with strong rental yields and capital growth potential.
• Family Asset: For properties intended as long-term family holdings, prioritise stability and future inheritance value.

Remember, the property will be registered in the name of the trust, not the individual beneficiaries. This means the trust must ensure compliance with any legal or tax obligations specific to trust-owned properties.

Step 4: Completing the Purchase

When the trust decides on a property, the trustee handles the purchase process, including:

• Signing the contract of sale: The trustee signs on behalf of the trust, ensuring all details align with the trust deed.
• Paying the deposit: This typically comes from the trust’s funds or the approved loan.
• Finalising settlement: The property’s title is registered in the name of the trust, and any remaining funds are transferred to the seller.

It’s important to work closely with a conveyancer or solicitor who understands trusts to ensure all legal and financial obligations are met.

Step 5: Managing the Property

Once the property is acquired, the trustee is responsible for its ongoing management. This includes:

• Collecting rental income (if it’s an investment property).
• Paying expenses, such as rates, maintenance, and loan repayments.
• Distributing income to beneficiaries as outlined in the trust deed.

For example, If a trust earns $50,000 in rental income, the trustee can allocate $20,000 to a low-tax-bracket beneficiary and $30,000 to another, reducing overall taxes.

Why Buy Property Through a Trust?

Using a trust to buy property has unique benefits. Let’s explore the key advantages.

1. Asset Protection

One of the biggest advantages of trusts is asset protection. Since the trust owns the property (not you), it’s protected from personal liabilities. If a beneficiary faces bankruptcy or legal action, creditors can’t claim the trust’s assets.

2. Tax Flexibility

Trusts allow you to distribute income among beneficiaries in a tax-efficient way. For example, income can be allocated to beneficiaries in lower tax brackets, reducing the family’s overall tax burden.

3. Estate Planning

Trusts provide clear rules for transferring assets after death, disability, or illness. This can prevent disputes and ensure your property is passed on as intended. Additionally, trusts can help minimise taxes when transferring assets to beneficiaries.

4. Profit Distribution

Whether it’s rental income or proceeds from selling a property, trusts simplify wealth distribution. The trustee ensures income and profits are shared fairly and in line with the trust deed.

Curious about how a trust can protect your assets and reduce taxes? Schedule a free consultation with our mortgage brokers today.

Challenges and Risks

Trusts have benefits, but they also come with challenges. Here’s what you need to know.

1. Negative Gearing Limitations

One of the most common strategies in property investment is negative gearing. This involves using a loss on the property (where expenses exceed income) to reduce your taxable income. However, this benefit isn’t directly available for properties held in a trust. Why?

In a trust, losses from a negatively geared property are “trapped” within the trust. This means they can’t be offset against your personal income, such as your salary. Instead, these losses must be carried forward within the trust and can only be offset against future income earned by the trust itself.

For example, if your trust-owned rental property incurs a $10,000 loss in a financial year, that loss remains in the trust until future rental income (or other trust income) offsets it. This can delay the financial benefit of negative gearing, potentially impacting your cash flow.

2. Main Residence Capital Gains Tax (CGT) Exemption

Selling your main home usually means you don’t have to pay CGT on the profit. However, this exemption doesn’t apply to properties held in a trust. Why? Because the trust, not you, is the legal owner of the property, and trusts don’t qualify for this personal exemption.

Imagine you’ve held a trust-owned property for several years as your main residence. If the property appreciates in value and you decide to sell, the trust will be liable for CGT on the gain. Depending on the value of the property, this could mean a substantial tax bill. This is something individuals wouldn’t face for their main residence.

This limitation makes trusts less suitable for properties intended as your primary home and more appropriate for investment properties where CGT concessions still apply after holding the property for over 12 months.

3. Setup and Maintenance Costs

Establishing a trust isn’t cheap. The setup costs typically range from $3,000 to $5,000 (plus GST), depending on the complexity of the trust deed and the professional fees involved. But the costs don’t stop there.

Trusts require ongoing maintenance, including:

• Annual accounting and tax filings.
• Regular trustee meetings and minutes.
• Compliance with legal and financial obligations.

These administrative requirements can lead to additional yearly costs, often in the thousands of dollars. It’s essential to weigh these expenses against the potential benefits of the trust. For example, if the trust’s tax savings or asset protection don’t outweigh its costs, it might not be the best choice for your situation.

4. Financing Challenges

Securing a loan for a property held in a trust can be significantly more complicated than for personal ownership. Here’s why:

• Fewer Lender Options: Not all lenders provide loans for trusts. Those that do often route these applications through their business or commercial divisions, which may have stricter criteria.
• Stricter Requirements: Lenders typically require all trustees and beneficiaries to act as guarantors. This can involve more paperwork and create added obligations for those involved.
• Higher Interest Rates and Lower Loan Limits: Loans for trusts are considered higher risk by lenders, leading to higher interest rates and lower LVRs. For example, you might only be able to borrow 70–80% of the property’s value, compared to 90–95% for personal home loans.

Let’s say you’re purchasing a $1,000,000 property through a trust. With an LVR of 70%, you’d need to contribute $300,000 upfront as a deposit. This higher equity requirement can be a hurdle for many investors.

5. Potential Legislative Changes

Tax laws governing trusts have evolved over the years, and there’s always the possibility of further changes. Australian regulators periodically review how trusts are used, particularly for property investment and tax planning. While discretionary trusts remain a popular tool for families and small businesses, any significant legislative change could impact:

• The taxation of trust income.
• Eligibility for CGT discounts.
• Deductibility of expenses.

For example, if new rules were introduced to limit income splitting between beneficiaries, the tax benefits of a discretionary trust could be affected. Staying informed and working with a professional who monitors these changes is critical to ensuring your trust remains compliant and effective.

Trust loans can be complex, but you don’t have to handle it alone. Get expert support from our experienced brokers and make the process hassle-free.

Final Thoughts

Using a trust to buy property is a smart option for Australians looking for asset protection, tax benefits, and help with estate planning. However, it’s not always the right choice. Trusts come with costs, challenges, and limits, so it’s important to carefully consider whether they suit your personal situation.

If you’re feeling unsure or have questions, don’t worry. That’s where we come in. As finance brokers in Sydney, we’re here to guide you through the process, answer your concerns, and help you decide if a trust is the right fit for you. Reach out for a friendly chat. Together, we’ll make sure you’re confident in your decision.

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