Mortgage Experts Blog
Borrowing with a trust
Borrowing involving a trust. If you ever considered owning real estate through a trust (including through your Self Managed Super Fund) then this may be of interest to you. Off course seek your own advice and don’t rely on this information solely. Trusts are predominately used for asset protection, tax minimisation and succession planning. The main types of trusts used when borrowing are discretionary trusts (family trusts), unit trusts, self managed super fund trusts and to a lesser degree hybrid / property investor trusts.
Outside of the self managed super fund arena there are three main reason people use a trust to acquire an asset. To protect their assets, to minimise tax and to provide flexibility in the future. On the tax minimisation front it is possible to have a trust set up that allows tax deductible interest at the individual tax level and but I believe they are under the microscope of the ATO and are harder to finance. So really borrowing through a trust will probably best suit people looking to protect their assets, provide flexibility of ownership in the future (sucession planning) and people with a large enough deposit to make an investment property neutrally or positively geared from the outset.
What is a trust exactly?
A trust is an arrangement which allows a person or company to own assets on behalf of another person, family or group of people. These people are known as the beneficiaries of the trust. Assets are owned on behalf of “beneficiaries” and are controlled by a “trustee” who can be either a corporation or a natural person. The trustee is governed by a “trust deed” which sets out the rules that the trustee must follow and also covers how profit is distributed to the beneficiaries.
Why borrow through a trust
The two main reasons to consider borrowing through a trust are to protect assets, take advantage of possible tax benefits.
- Asset protection
Asset protection is probably the biggest attraction of using a trust. Assets held through trusts are not legally "owned" by beneficiaries, meaning that trust assets are protected from the liabilities of those beneficiaries. Off course the lender who lends to the trust will always protect themselves by requiring the appropriate guarantees and indemnities. All other creditors will be blocked from going after the assets of the trust though. Unit trusts do not offer the same protection as discretionary trusts.
2. Tax benefits
The Government introduced the biggest tax advantage in choosing a trust rather than a company for owing property when it created a 50 per cent exemption from capital gains tax for all individuals, and the exemption was explicitly extended to the beneficiaries of trusts but not to the shareholders of companies.
Income splitting - distributing investment income between members of a family to take advantage of lower marginal tax rates - has been partly curtailed. Distributions to children under the age of 18 are now penalised with tax at the top marginal rate and the low income offset payments for low income earners have been recently legislated against if distributions are from a trust. While the ability to split income between spouse’s remains.
3. Flexibility for the future
Another important advantage of using trusts is that it facilitates the tax-free passing of assets between generations. While property can be transferred tax-free upon death by the use of an ordinary will, owners are able to effectively transfer their assets to their children before death by using trusts.
Trusts that lenders will lend to
There are many types of trusts but to get a loan care should be taken in choosing which type of trust you go with. Many residential mortgage brokers and bank employees / lending managers are not up to speed with trust and company lending and for that reason many lenders do not offer loans to trusts. Many lenders will direct trust borrowers to their commercial lending division which can mean you pay a significantly higher interest rate and fees than you would for a residential loan.
I am across the various lending policies that relate to trusts and I can help find you the most cost effective solutions.
Discretionary Trusts (including Family Trusts)
A Family Trust is a type of discretionary trust and is the most common type of trust. They are generally set up to hold a family’s assets and/or businesses for the benefit of providing asset protection and tax planning for family members. The income and assets from the trust can be distributed to the beneficiaries as the trustee see fit as long as the trust deed rules are followed.
If you intent to borrow through a trust we recommend that you use a family trust as this gives you the most borrowing options. Having a personal trustee will allow you more lending options. However this is a weaker structure for asset protection and makes it harder to change who controls the trust ie makes it harder to change the trustee. Also the trust will hold losses ie you can’t negative gear with a discretionary trust.
Who are the borrowers?
The borrower would typically be the trustee in their capacity as trustee for the family trust. In the case of the company trustee the directors would be required to give directors and personal guarantees. One contentious point is also many lenders require any of the adult beneficiaries of the trust to also give personal guarantees even if they are not involved in the trustee company.
Who is on title?
The trustee. A company trustee has the advantage of being able to change the directors of the trustee company. This means a trust could effectively change the person controlling the trust without incurring transfer duty (stamp duty).
A unit trust is like a company where the trusts property are divided into a number of shares called units. The number of units you hold will determine your entitlement to your share of income, capital gains and voting power. Units in a unit trust can also be categorised. For example you can have income units and capital units. Also unit holders can be individuals, companies or another trust. The taxation benefits are generally not as flexible as a discretionary trust in that any income distributions must be distributed to unit holders as per their share of units. However if a discretionary trust was a unit holder you can achieve the same flow through tax benefits. From an asset protection point of view, unit trusts don’t provide the same kind of asset protection as a discretionary trust. If a unit holder is made bankrupt, then that persons units will be treated like any other assets and sold to raise funds to pay creditors. Unit trusts are most common for non family members or a blend of family and non family members.
Residential rate loans to unit trusts are available through a limited number of lenders.
Hybrid trusts are trusts that combine features of discretionary and unit trusts. Most lenders will not lend to hybrid trusts but there are a still a few lending options available. Hybrids are mainly used so that individuals can claim the same tax benefits as if buying in their own names initially when the property is negatively geared and can at a later date have the trust act like a normal discretionary trust. This would usually be once the property is positively geared.
The usual set up is for the individual unit holders of the trust to borrow in their own names while the trustee goes on the title of the property. The loan to the individuals is actually to purchase units in the trust, while the trustee uses these funds to help it acquire the property. As the loan and property settle at the same time the lender never actually advances the monies to the the individuals. At a later date the trustee company buys the units back from the individuals usually via a refinance of the loan balance into the trustee's name.
Property Investor Trust (PIT)
This is the same in all but name to a hybrid trust. See above.
Self Managed Super Fund (SMSF) Trust
A SMSF is a special type of trust that people can set up to manage their own superannuation. Like a normal super fund, your employer contributions still get paid into the fund and you can still make additional contributions as you see fit. Unlike a normal super fund, the trustee (normally you or a company controlled by you) has direct control over the assets that your superannuation is invested in.
A select few lenders now offer loans to SMSF trusts to allow them to invest in residential property up to an LVR of around 80%. The interest rates offered are around the normal home loan rates + a margin of around 0.5% - 1.0% pa so not too prohibitive. However the legal fees and complexity to set up the various entities involved puts a lot of people off.
The SMSF borrowing structure is usually set up as follows:
- A loan is given to the SMSF Trustee.
- The “Security Custodian” purchases the residential investment property on behalf of the Super Fund.
- The Security custodian (which must be a limited liability company) then holds the property as an asset in trust for the Super Fund.
- The super fund has the beneficial right but not the obligation to acquire the underlying asset at a future date (when the loan is repaid).
- The loan is secured against the investment property and while the loan is ideally self-servicing from the rental income derived from the property, servicing may also come from any other income received or assets held by the SMSF Trustee.
- The loan is limited in recourse, with the Bank’s right against the SMSF Trustee limited to the lenders right as mortgagee in relation to the property.
- There is no recourse to any other assets of the SMSF or to either the SMSF Trustee or Security Custodian.
The tricky point here is that although they say the loan is non recourse, lenders being lenders they can’t help trying to get a bit more security. So most require director’s guarantees from the security custodian which by the way just so happens to be the same people in most cases as the beneficiaries of the super fund!!So while they can't touch the SMSF's other assets they can come after the members personal assets.
If lenders don’t take some sort of extra guarantees the LVR’s offered will be lower and the interest rates potentially higher. Usually 50% or less for no guarantees.
My advice is simply be sure you really need a trust structure before you pursue the idea any further. If you do wish to pursue a trust structure please make sure you have the trust set up before attempting a purchase. Also please remember we are not accountants or solicitors so while we have a good understanding of trusts from a layman's point of view please seek your own professional advice.
Feel free to contact us to discuss you trust loan options at any time.