Debt Recycling v Borrowing Extra to Invest

Strictly speaking borrowing to invest is a different strategy to debt recycling.

Borrowing to invest could incorporate debt recycling, but it is really about borrowing extra money to invest over and above what you have already borrowed.

Debt recycling, on the other hand, is about converting existing non-deductible debt into deductible debt. It doesn’t involve any additional borrowings.

Example

Bart has a home worth $1mil and an owner-occupied debt of $400,000. Bart borrows an extra $200,000 to invest in income producing shares.

Loan A           $400,000           Non-deductible

Changes to

Loan A $400,000      Non-deductible = still the same

Loan B $100,000           Deductible

$400,000 total Debt

Lisa on the other hand wants to debt recycle and she has a home worth $1mil with a loan of $400,000 which is non-deductible. She also has $150,000 in the offset account and wants to invest in shares.

Loan A $400,000      Non-deductible      with $150,000 in attached offset

Changes to

Loan A $300,000      Non-deductible with $50,000 in attached offset

Loan B $100,0000           deductible when drawn down to buy shares

$400,000 total Debt

Of course, borrowing to invest and debt recycling can be combined, and this is what Maggie does. She has a $1mil main residence with $400,000 owing on it and $150,000 in an offset account. She also wants to buy shares but wants $200,000 worth

Loan A $400,000      Non-deductible      with $150,000 in attached offset

Changes to

Loan A $300,000      Non-deductible with $50,000 in attached offset

Loan B $100,0000           deductible when drawn down to buy shares

Loan C $100,0000

$500,000 in total debt

Maggie has used $100,000 to debt recycle as well as borrowing another $100,000 on top for further investments. She could potentially even combine loans B and C above.

Discuss at

https://www.propertychat.com.au/community/threads/tax-tip-219-debt-recycling-v-borrowing-extra-to-invest.39792/

Are Shareholders Liable for the Debt of a Company?

A worry for some people is that if they become shareholders of a company, they could somehow become liable for the debts of the company.

This is not the case unless the shareholders give a personal guarantee or become directors of the company perhaps.

Example

Bart invests in Barney Pty Ltd which is a construction company. The company has virtually no assets. One day one of the staff members is seriously injured and sues the company. The company collapses and Bart is worried ‘they will come after him’.

This is generally not possible because Bart is a separate legal person to the company. His shares will be worthless, but there is where it ends.

However, there are some limited exceptions to this rule those for cases of fraud, the company acting as agent for the shareholder, shadow director roles, shams, parent companies and subsidiaries – all of which are very rare.

Caselaw

The King v Portus; ex parte Federated Clerks Union of Australia (1949) 79 CLR 42

“The company…is a distinct person from its shareholders. The shareholders are not liable to creditors for the debts of the company. The shareholders do not own the property of the company…” (at 435)

Discuss at

https://www.propertychat.com.au/community/threads/legal-tip-218-are-shareholders-liable-for-the-debt-of-a-company.39770/

Why you should avoid appointing a successor appointor in a Trust via a will

I often see discretionary trust deeds which nominate the next appointor, upon the death of the current appointor, to be the Legal Personal Representative (LPR) of the last appointor upon their death. On death the LPR of the deceased is the executor or administrator of the will.

This is a bad idea!

Example

Homer has set up a trust without getting legal advice. Homer is the sole appointor of the trust and there has been no thought given to what happens after his death. The deed is worded in such a way that the LPR of Homer will become the next appointor. The trust holds assets of approx. $2mil when Homer dies.

What could happen?

  1. Homer’s will appoint his mate Barney as his executor – Barney is now appointor of the trust and removes the current trustee and appoints a company he controls, or
  2. Homer’s nominated executor refuses to act and it ends up being the public trustee that becomes the LPR. They would immediately remove the trustee and appoint a trustee that they control. This would be much safer than Barney being in control, but they may have different ideas on who can benefit from the trust, or
  3. Aunt Thelma could be the only one that applies for Administration of Homer’s estate as he died without a valid will. She is the LPR. Now she is the appointor of the trust. She is also a beneficiary of the trust and the trust deed permits the trustee to act even though there may be a conflict of interest. Thelma could milk the trust and benefit herself at the expense of Homer’s children
  4. More practically speaking, the LPR is only appointed once the courts have granted Probate or Administration. This could take 6 months of more. So until this happens the trust will be without an appointor. If the deceased person was the trustee or the sole director and shareholder of the trustee company the trust will be under no one’s control until the LPR is appointed. This means no access to bank accounts, no ability to make a beneficiary presently entitled to income, of it crosses the end of June, which means the top marginal tax rate on all trust income. Any sales of property won’t be able to happen, contracts entered into may not be able to be completed – litigation potentially resulting.

Solution – seek legal advice about appointing a successor appointor now, via a separate deed. If the trust deed doesn’t allow this, seek legal advice on having the deed amended to allow it.

Keep any clause relating to the next appointor being nominated in the will as a back up, and avoid having the LPR being the next appointor.

Discuss at

https://www.propertychat.com.au/community/threads/legal-tip-216-why-you-should-avoid-appointing-a-successor-appointor-in-a-trust-via-a-will.39689/

Tax Trap Demolishing the Main Residence and Selling Land

The main residence exemption only applies to land with a residence on it – a hint is in the phrase ‘main residence’!. If you were to demolish the house and sell the land you could be in for a nasty surprise as there would likely be CGT applicable. GST might be an issue also.

Example

Homer purchased a main residence in 2010 for $1mil. It was dilapidated when he bought it and it has only become more run down since. Luckily the land value alone is now worth $2mil and Homer is negotiating with a developer.

They agree on $2mil on the condition that Homer remove the house.

Homer knocks the house down and stays in a 5 star hotel with a butler service for the full 42 day settlement period. It will cost him about $40,000 but, heck, he has earned it and deserves it for making a $1mil tax free capital gain.

Later Homer does his tax return and finds out that the main residence exemption cannot apply!

No problem says Homer, the value didn’t increase much by him knocking the house down.

However, Homer is shocked for a second time because the cost base of the property will be, basically, the purchase price plus costs such as stamp duty and a few other fees and charges and the demolition cost. Perhaps $1.1mil in this case. This could mean a capital gain of about $900,000.

That would be about $450,000 additional income for Homer, how as head scientist at Lucas Heights is already on the top tax rate which means he has made a mistake of about $211,500 plus the $40,000 for the hotel!

Had Homer sought advice there may have been a way to structure this so that the main residence exemption remained, and the demolition occurred.

Strategies to keep the exemption may be to pay for the demolition after settlement, or to give the developer possession before settlement or just reduce the price by the cost of demolition.

Posted 21 Jun 2019

https://www.propertychat.com.au/community/threads/tax-tip-216-tax-trap-demolishing-the-main-residence-and-selling-land.39677/

Asset Protection and Clawback Provisions

When entering any transaction, especially related party transactions, consider the clawback provisions under the Bankruptcy Act, the 2 main ones being:

Section 120. Undervalued transactions see

http://www.austlii.edu.au/au/legis/cth/consol_act/ba1966142/s120.html

Section 121. Transfers to defeat creditors

See http://www.austlii.edu.au/au/legis/cth/consol_act/ba1966142/s121.html

Most people forget about the state legislation as well:

e.g. Conveyancing Act 1919 (NSW)

Section 37A. Voluntary alienation to defraud creditors voidable

See http://www.austlii.edu.au/au/legis/nsw/consol_act/ca1919141/s37a.html

Each State has its own legislation similar to the s37A

What the above sections mean is that a transaction entered into with the intent of defeating creditors or putting property out of reach of the trustee in bankruptcy (if you were to go bankrupt) could be attacked. This can even apply to future creditors.

So, take care in how you do things, especially related party transfers such as changing title on property, declaring trusts or moving cash.

Discussion at

https://propertychat.com.au/community/threads/legal-tip-2-asset-protection.224/

Strategy of Borrowing from a Testamentary Trust instead of Winding it Up

Testamentary Discretionary Trusts (TDT) are the best sort of trust out there, but someone has to die for them to come into existence. So, they are relatively rare. Also, the capital of the trust has to come from the deceased for the extra tax benefits to work (excepted trust income).

So, I cringe when clients approach me wanting to wind up a TDT that their parent has left them in control of.

Their idea usually goes something like this. I have a $1mil loan on my main residence and the trust holds $1mil worth of assets. If I wind up the trust, I can pay off my home loan and save interest.

It is a valid point, but once a TDT is closed it can’t be reopened again, and even if kept open new capital can be injected, but income generated from it would not qualify as except trust income and would not get the concessional tax treatment in the hands of children.

There is a simple way around this though, and that is to get the trustee to make you an interest free loan.

Example

Bart’s dad Homer dies and leaves $1mil to a trustee of a TDT set up under his will. Bart has a $1mil home loan so winds up the trust and pays off the loan.

Lisa is in the same position, but she controls a separate, but identical trust. Lisa gets the trustee to lend her $1mil interest free which she uses to pay off her loan. She has not no deductible debt now. So, she uses the $3,000 she was paying the bank each month to pay back the trust.

The trust now has money with which to invest. The income from these investments can go to Lisa’s children tax free – because they can each earn $20,000 pa tax free so it will be ages before the trust’s income is more than this.

Meanwhile Bart is making the same investments as Lisa, but he receives the income himself and is taxed at 47%

Over the next 15 years or so Lisa would have probably repaid the full $1mil back to the trust so it is now generating about $40,000 per year in income which comes out tax free to her kids.

Once the kids start working, she will have to reassess where the income goes, but until then there are huge savings.

Tip – Don’t wind up a testamentary trust without careful consideration and legal advice.

Note that this would also give great asset protection as well.

Discussion at:

https://www.propertychat.com.au/community/threads/legal-tip-115-strategy-of-borrowing-from-a-testamentary-trust-instead-of-winding-it-up.39662/

Transfer of Property to a Special Disability Trust and Stamp duty Exemptions

In NSW there is a stamp duty exemption for the transfer of property to a Special Disability Trust (SDT). This can apply for a declaration of trust s65(22)(a) or (b) Duties Act 1997 (NSW) or for a transfer to the trustee of an SDT s65(22)(c).  http://www8.austlii.edu.au/cgi-bin/viewdoc/au/legis/nsw/consol_act/da199793/s65.html

There are similar provisions in other states too, including:

Section 38A Duties Act 2000 (VIC)
http://www8.austlii.edu.au/cgi-bin/viewdoc/au/legis/vic/consol_act/da200093/s38a.html

Section 126A Duties Act 2001 (QLD)
http://classic.austlii.edu.au/au/legis/qld/consol_act/da200193/s126a.html

 Example

Homer has an investment property which he wishes to transfer to a special disability trust for his daughter who has a severe disability. Title is transferred from Homer’s name to that of a professional trustee and there is no stamp duty charged on this transfer.

Note that there are also CGT exemptions available too.

See:

Tax Tip 159: No CGT on Transfer to a Special Disability Trust            https://www.propertychat.com.au/community/threads/tax-tip-159-no-cgt-on-transfer-to-a-special-disability-trust.23076/

Discuss at

https://www.propertychat.com.au/community/threads/tax-tip-215-transfer-of-property-to-a-special-disability-trust-and-stamp-duty-exemptions.39643/

Loan Tip: Not everyone needs an Offset Account

Offset accounts are great and most people should have at least one offset account, but there are situations where an offset account is not necessary.

Three situations I can think of are

  1. Someone with low cash savings, and unlikely to have cash savings
  2. Where the interest rates are higher on offset loans
  3. Where there are large annual fees

Example

Example

Loan product with an offset account is 3.8% and without an offset account is 3.4%

Interest on $100,000 at 3.8% = $3,800
interest on $100,000 at 3.4% = $3,400

The question is at what point does 3.8% rate equal $3,400 and working backwards this seems to be $89,474. so this means $10,526 in an offset or more could result in savings

Therefore,
interest on $100,000 at 3.8% with $10,526 in an offset = $3,400
Interest on $100,000 at 3.4% with no offset =$3,400

So this means unless the borrower has $10,526 in the offset, or more, they would be better off without an offset account.

Also offset loans often have a $395 annual fee. So that might mean about $20,000 is needed to be ahead.

Another situation where an offset may not be needed is where a person intends to smash the loan down and has no intention of investing. But in these cases I would probably suggest an offset account because circumstances change unpredictably.

Discuss at

https://www.propertychat.com.au/community/threads/loan-tip-not-everyone-needs-an-offset-account.39612/

At what date is CGT Triggered? Part 1

Working as a trainee lawyer in a small suburban firm I heard a staff member, who wasn’t even a lawyer, tell a conveyancing client that the relevant date for CGT purposes is the date of settlement and not the date of contract. How wrong she was.

Generally*, where a capital asset is purchased or sold under a contract the relevant date for CGT purposes is the date the contract is entered into, s 104-10(3)(a) ITAA97 (CGT event A1).

See http://classic.austlii.edu.au/au/legis/cth/consol_act/itaa1997240/s104.10.html

Timing is very important if an investor wants to sell the property about 12 months after buying it because a few days difference can mean a lot of extra tax .

Example

Bart buys a property on 28th of June for $500,000– he enters contracts on this date, but settlement is on 28th of July. The relevant acquisition date for CGT purposes is 28th of June. Bart gets a keen buyer interested in the property and they want to sign the contract to purchase it on 27th of June the following year for $1mil with settlement on the 1st of August. Bart thinks, great that is more than 12 months from settlement to settlement so he thinks he will get the 50% CGT discount.

But Bart is wrong because it is the contract dates that count – 28th of June this year and 27th of June next year. Less than 12 months so no 50% CGT discount.

Bart’s capital gain is $500,000

Had he sought advice and waited 2 more days his capital gain would have been $500,000 still, but the taxable capital gain would have been halved to $250,000.

Timing is also very important as to which financial year the gain will be taxed in.

Example 2

Lisa is selling her investment property and is in negotiations with a prospective buyer. It is late June and Lisa wants to make sure the gain is taxed in the next financial year as she will be off work all year and will have no income. This year she has already earnt $200,000 in taxable income.

Lisa signs contracts on 1 June this year with settlement on 15th June next year. She thinks the relevant date is the settlement date. The gain before the discount is $200,000.

If the sale falls into this financial year the tax would be $47,000

If the sale falls into the next financial year the tax would be $25,717

(based on 2018 and 2019 tax rates respectively)

*Note that I said ‘generally’ at the beginning above, and that is because there are instances where the relevant date is the settlement date, and sometimes it is somewhere between the date the contract is signed and settlement happens. I will cover these in a future tax tip.

17 Jun 2019

https://www.propertychat.com.au/community/threads/tax-tip-214-at-what-date-is-cgt-triggered-part-1.39595/

How to Save Capital Gains Tax on Investment Property (Part I)

Below are some ways in which CGT may be reduced on the sale of an investment property. But before you decide to sell you should properly work out what the potential size of the capital gain will be. Once you know what you are dealing with you will then be able to work out appropriate strategies to reduce the amount of tax payable.

1. Timing of the sale

Usually it is the date of the contract entered into that is the relevant disposal date for CGT purposes. Some things you can do:

a) Bring forward the sale so that it falls into a year of low income, or

b) Push back the sale so that if falls in a later year where you expect to have lower than usual income. Delaying the sale can also allow for more time to plan and implement other strategies.

c) Time the crystallising of losses (see below)

d) Make sure you have held the property for the full 12 months for the 50% CGT discount

2. Offset Capital Gains with Capital Losses

Capital Losses can be used to offset capital gains. Losses can result from:

a) Carried forward losses from prior years, or

b) Current year losses arising from the sale of other assets.

Bring forward the sale of other property or shares that have dropped in value may help. But you have to get the timing right. Selling the shares with the capital loss in a later tax year to the sale of the property with the capital gain will result in no offsetting and the capital loss being carried forward to be offset against some future potential capital gains.

Take care with the sale of shares and then immediately buying them back as the ATO may want to deny the deduction as they can deem this to be a wash sale with the sole purpose of a tax benefit.

3. Claim everything possible

When working out the capital gains tax the cost base of the property needs to be worked out. Various expenses incurred during ownership can be used to reduce the amount of CGT payable. So it is essential not to miss any potential deduction as this will result in more tax being payable.

See my tax Tip on this: Tax Tip 76: Calculating the Cost Base for CGT purposes.

4. Small Business Concessions

Often overlooked are the small business concessions which may be used to reduce the CGT (sometimes to nil) where the property has been used as part of a business.

There are 4 main small business CGT concessions, namely:

a) the small business 15-year exemption

b) the small business 50% active asset reduction

c) the small business retirement exemption and

d) the small business rollover

@MikeLivingTheDream first gave me the idea of using the 4 small business concessions.

5. Reducing your Taxable Income

Any capital gain is added to your other taxable income for the year so look at ways to reduce your income. There are 2 aspects to working out taxable income:

a) Earnings, and

b) Deductions

Either reducing earnings or increasing deductions will result in less tax, Combine the 2 and your savings will be greater still.

5a. Reduce Earnings

Not many would want to reduce their earnings, but here are some suggestions for those that do:

• Taking that leave without pay that you always wanted may work in well with reducing your earnings;

• Salary sacrificing into super can also reduce your taxable income;

• Change from full time to part time;

• Quitting to travel the world.

• Where self-employed you may be able to delay income.

• Salary sacrifice into super

See Taking a Year off Work to save CGT

Before prepaying interest, you should consider the flow on effects for later years – where you will have little to no interest claimable which may result in more tax payable. Also, be aware that you cannot just pay into the loan, but must actually fix the loan for 1 year and

5b. Increase Deductions

Having greater deductions will mean you have less taxable income. Some ways to increase deductions, other than the usual claiming everything you can, are:

• Prepay interest on other investment properties

• Donations

• Deductible contribution into super where possible.

6. Die in your investment property

As you approach death move into your investment property with the biggest gain and rent out the main residence.

Usually, it is difficult to get the timing right on this one!

Stay tuned for Part II

Discussion at:  https://propertychat.com.au/community/threads/tax-tip-119-how-to-reduce-cgt-on-investment-property-part-i.10681/