Can you own your personal place of residence inside of a family trust?

Welcome to Finance and Fury, the Say What Wednesday edition, every week answering your questions. This week we answer Stephen’s question:

“Hi Louis,

I saw an article about purchasing a home inside of a family trust for asset protection. I’m just wondering if you have seen this done before and if you think it is a good idea?”

Thanks for the question – this episode – look at purchasing your own personal place of residence inside of a family trust – and what the pros and cons of this strategy are – because in short – it is definitely possible to do, but if not done correctly – it can put you in a worse position

Quick note – I’m not a legal expert – if you are considering this – important to get expert advice on this – this episode will just be discussing the general gist of the concept – and potential ways to avoid some of the major cons

Firstly – What is a family trust – or discretionary trust –

1. family trust refers to a discretionary trust set up to hold a family’s assets – set up as a different owner of assets than someone individually owning an asset –
   1. On a family trust – you have the trustee which is the person that owns or controls the asset
      1. Corporate or individual
   2. the beneficiaries of the trust are the person(s) for whom the asset (e.g. a property) is owned –
   3. Have other entities like the appointer – power to add and remove the trustees –
2. A family discretionary trust is probably the most common type of trust if someone was wanting to invest in a property
   1. The trustee can use their discretion to distribute the trust’s income and assets to the beneficiaries, allowing the family members to take advantage of tax benefits
   2. It also provides asset protection – if you are a director of the corporate trustee – technically you don’t own the assets inside of the trust
3. So you can own lifestyle assets like you own home inside of a family trust –
   1. Quick note -this doesn’t work for a SMSF – it is inside the superannuation environment and to hold any asset here – it needs to meet the sole purpose test –
   2. This is that any assets are for your retirement solely – so buying a property to live in inside of this structure breaches this and you cant live in it

However – there are some Issues and considerations that need to be made for owning a property inside of a family trust –

owning property in a trust for asset protection purposes will usually mean that you lose its tax-free capital gains status as well as creating land tax implications

1. Not normally an issue for investment properties – as CGT is payable anyway as it is an investment given it gets an income
   1. However – losing this on a PPR could be a major deal – buying a home for $600k and then a decade later selling it for $1m may result in $200k of additional assessable income being taxed at marginal tax rates (getting the 50% CGT discount) – may result in around $94k of tax payable at the highest MTR
2. Looking at the CGT exemptions – Can a family trust claim a CGT exemption for the principal place of residence?
   1. Technically – the answer is no – as the trust is not a natural person it fails to meet the PPR CGT exemptions – so normally if someone wanted to claim a CGT exemption for a principal place – this would fail and CGT would be payable upon the sale of the property –
   2. Even the ATO on their website have the following: Generally speaking, the main residence exemption does not apply to the sale of assets held by trusts, as a transfer of a CGT asset to or from a trust will create a CGT event. Therefore, transferring the title of the property from a trust to personal names will also create a CGT event
   3. ATO rules – Generally, if you are an individual (not a company or trust) you can ignore a capital gain or capital loss from a CGT event that happens to your ownership interest in a dwelling that is your main residence (also referred to as ‘your home’). To get the full exemption from CGT:
      1. the dwelling must have been your home for the whole period you owned it
      2. you must not have used the dwelling to produce assessable income

• any land on which the dwelling is situated must be two hectares or less, and

1. you must not be an excluded foreign resident at the time the CGT event occurs.
2. However – in the income tax assessment act – Paragraph 160 ZZQ12(a) requires that a dwelling be owned by a natural person
3. And a family company or family trust is not a natural person for these purposes.

• However, where a beneficiary of a trust is absolutely entitled as against the trustee to the dwelling, an exemption may be available to the beneficiary if the dwelling is the principal residence of the beneficiary.

1. So this means there is a way around this – but it can be complex and costly to achieve
2. A Main Residence Trust can be created – it is like a discretionary form of trust, under which an individual is given a limited form of interest sufficient to attract the CGT Main Residence Exemption – in other words – the beneficiaries of the trust who reside in the property are given absolute entitlement
   1. To do this – in the trust deed – has to set out an equitable right of residence that is granted from the trust to a beneficiary
      1. But this needs to be sufficient to give an interest in the land that will attract the main residence exemption. Hence the term absolute entitlement
      2. Therefore – If the property is sold in the future, the sale can be structured so that the CGT exemption can be applied.
   2. Does this then fail the asset protection – i.e. the whole point of owning a property in the trust? Why give absolute entitlement if it can be taken away –
      1. Well – as a discretionary form of trust – provided that the trust deed is appropriately worded – no beneficiary can be said to have any interest in the assets of that trust – whilst they may have an absolute entitlement on paper – this doesn’t mean they have any financial interest in the property – or claim to the assets value – so this means that if any of the persons who are simply beneficiaries suffer financial calamity or are sued personally – the trust assets will not be available to satisfy the debts of that beneficiary – so if you get sued then the property can’t be used as collateral
   3. There is another way around this – if the trust deed hasn’t been set out correctly – and if the trust already owns the individuals main residences – to get the CGT exemption – a long term lease may be needed
      1. Some people see this as a suitable option to formalise the living arrangements and ensure access to the main residence CGT exemption if a sale occurs in the future
      2. Under a long term lease arrangement, the tenant obtains an “ownership interest” in the residence
         1. Have to specify this as ownership interest is the term is used in the capital gains tax ‘main residence’ exemption legislation

• Upon the sale of the property – the tenant (i.e. you) would be entitled to a surrender payment in return for the actual surrender of the tenancy
  1. This surrender payment would be assessable income in the hands of the tenant and provided that the arrangement has been properly structured and administered, would attract the main residence exemption.
  2. However – The value of the land upon sale would be reduced by the value of the long term lease
  3. So the total market value of the interests in the property would be divided between the land value and the lease value – and rent would be nominal so that the long term value of the lease to the tenant would be substantial enough to offset the assessable surrender payments – so no tax should be payable

1. These forms of main residence Trusts and Long Term Leases can be difficult and complex to setup from a legal and tax perspective – may cost a few thousand dollars to set up and maintain each year

3. The other issue is land tax – however – there are some ways around this – does vary state by state – so gain to get advice on this –
   1. But generally – If the land value inside of a trust is more than $350k in QLD, or in NSW it is a flat 1.6% of the land value inside of trusts – can get expensive
   2. So similar to the CGT exemptions – Trustees eligible for the principal place of residence exemption also include the beneficiaries who also reside in the property – QLD is pretty cut and dry
      1. Technically – The exemption is not available for land owned by a trustee of a discretionary trust, a unit trust scheme or a liquidator – However, concessionary tax treatment is available for land held by a trustee of a discretionary trust or a unit trust scheme which is occupied by a beneficiary as their principal place of residence – however the trustee needs to nominates that person as the principal place of residence beneficiary
      2. You have to nominate this with the government in each state however
   3. So as an example – if you have additional investments inside of the trust – and you list your children as beneficiaries for tax purposes – distributions
      1. If they move out – but are still beneficiaries – can run afoul of these rules
      2. Hence it may be better to set up a trust, call it the main residency trust – for the sole purpose of owning your PPR

So, in short – it is possible to overcome these two major downsides of ownership of property inside of a family trust – I have seen this done before – but there wasn’t much point to it

 Questions to consider –

1. How badly do you need asset protection –
   1. The asset protection that most family trusts provide is for external litigators of issues – outside of family
   2. It doesn’t provide protection against divorces or in the family courts –
2. Is the cost versus benefits worth it – the upfront and ongoing costs can be, well, costly
   1. Have to look at the pros and cons for this – over a 20 year period it may cost you $40-60k to maintain the trust structure depending on legal and accounting fees – this is just an estimate – may be much more
   2. But these funds may be better spent paying off the debts

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