Transferring a Property from a Testamentary Trust to a Beneficiary Without CGT

Trusts are generally considered the greatest British invention, (the sandwich comes in second), and Testamentary Discretionary Trusts (TDTs) are the best of the best.

The main benefit of a TDT is the ability to get income into the hands of children and have them taxed as adults.

Another main benefit of TDTs is the ability to transfer a property owned by the trustee of the trust to that of a beneficiary of the trust without triggering CGT. This means an inspecie transfer of assets is possible without CGT.

Example

Homer dies and leaves his property portfolio indirectly to his children by establishing 3 separate TDTs in his will. Bart’s trust will hold 3 properties, as will 2 more trusts controlled by Bart’s sisters.

Bart has 5 children, so is able to distribute the $100,000 in rental income to the children tax free each year.

After a while the kids grow up and start working so any further distributions will result in tax being payable at high rates. Bart decides to reduce the tax by moving into the most expensive property and living there rent free. Then he realises that the property is subject to CGT as it is held by a trustee and the main residence exemption won’t apply.

Bart decides to use the ATO’s concession and transfer the property from the trustee to himself as a beneficiary under the will.

He gets a private ruling first and this confirms the Commissioner will not treat this as a disposal for CGT purposes because it is a transfer from a deceased estate to a beneficiary.

Note however that this is not law, but a concessional treatment by the Commissioner as stated in Paragraph 2 of PS LA 2003/12 https://www.ato.gov.au/law/view/document?docid=PSR/PS200312/NAT/ATO/00001

“… the Commissioner will not depart from the ATO’s long-standing administrative practice of treating the trustee of a testamentary trust in the same way that a legal personal representative is treated for the purposes of Division 128 of the ITAA 1997, in particular subsection 128-15(3).”

See also PBR 99991231235958 – Questions 1 and 2

also PBR 1012603789935

Discuss at

https://www.propertychat.com.au/community/threads/tax-tip-194-transferring-a-property-from-a-testamentary-trust-to-a-beneficiary-without-cgt.38844/

How long can Tax Losses be carried forward?

There is no time limit as to how long you can carry forward losses – whether income losses or capital losses, however they will be lost at death (a loss lost!). So, it makes sense that you should try to use up losses as early as possible. This is generally not too hard with income losses as these are easily eaten up the next financial year with more income being earned.

Using up capital losses tends to be more difficult though as a capital loss can only be used up by a capital gain – not general income.

Note that there are complex rules regarding companies and trusts in carrying forward losses.

Example

Homer invested money in a business he ran which failed. He lost $200,000 and has a $200,000 capital loss which he has been carrying forward for 9 years now. Homer would love to use this loss up, but the trouble is he has no other asset he could sell to offset the loss.

If Homer owned shares for example he could sell shares with a $200,000 capital gain and not have to pay any tax.

But losing his money has meant that Homer doesn’t have any capital to invest with.

However, Homer’s daughter Lisa knows a thing or 2 so sets up a discretionary trust to hold investments. It could be possible that in future a gain from the trust could be distributed to Homer and his loss could offset this so that no tax is payable.

Discuss this topic here

https://www.propertychat.com.au/community/threads/tax-tip-195-how-long-can-tax-losses-be-carried-forward.38902/

Declarations of Trust and CGT

I have outlined what a declaration of trust is here http://www.structuring.com.au/terry/trusts/declaration-of-trust/ .

What are the CGT consequences of a person declaring that they now hold an asset as trustee? There is no change in title, so most people probably think there are no tax consequences, but there are.

CGT Event E1 (section 104-55(1) ITAA97) happens when someone declares a trust over existing property they own. This is because there is a change of beneficial ownership, even though the legal ownership remains the same.

Example

Homer holds 100 shares in CBA. He makes a declaration of trust that he now holds these shares on trust under the terms of the Simpson Family Trust deed. No change of ownership has happened, but this has triggered CGT just as if there was a sale of those shares to a 3rd party. If the cost base of the shares was $100,000 and the market value is now $200,000 that would mean a $100,000 capital gain is made (which may then get the 50% CGT discount etc).

(Homer should have sought legal advice as there are ‘better’ ways of doing this)

The 2 broad methods of Debt Recycling

Broadly speaking there 2 ways to ‘debt recycle’.

Debt recycling is the conversion of ‘bad debt’ into ‘good debt’. See http://www.structuring.com.au/terry/recycling-debt/what-is-debt-recycling/

  1. Use the income from investments to pay down non-deductible debt, then borrow to invest further, or
  2. Selling investment assets and using the funds released to pay down the non-deductible debt and reborrowing

The best approach might be a combination of the 2 methods.

Example

Bart has owned a few investment properties for a few years. They are positive geared by $100 per week so that is about $5,200 per year in extra funds he can use to pay off his non-deductible home loan.

But the properties have about $500,000 in equity in them.

Bart only owes $400,000 on the main residence so what he could do is to sell the properties, pay the tax and used what is left to pay off the main residence debt, and to reborrow to buy more properties.

This way he uses a combination of the 2 debt recycling methods.

Of course, there is a lot else for Bart to consider such as, most importantly, his ability to qualify for finance to buy more properties.

Tax Strategy: Use Capital Losses Quickly – Recycle debt + death

Some people have carried forward capital losses. These losses can usually be carried forward until the taxpayer has a capital gain which can ‘soak up’ the capital loss.

I think it is a good idea to use up these losses as soon as possible.

The main reason being that losses are ‘lost’ at death. If the taxpayer dies their loss cannot be passed on to any other person who could utilise it. Don’t lose a loss!

Example

Bart bought a property in a mining town for $1,200,000. He ended up selling it for $700,000 and has a carried forward capital loss of $500,000.

Bart dies and leaves a rental property that he owns to his sister Lisa. The property has a $500,000 capital gain.

Unfortunately, Bart’s loss will not benefit anyone. Lisa will inherit the investment property pregnant with a $500,000 gain, yet she cannot benefit from the loss.

Had Bart sold the investment property before his death he might have made $500,000 tax free and this money could have been passed onto Lisa. He might have even sold the property to Lisa – perhaps with vendor finance if she couldn’t have afforded a loan. Also, if Bart had a flexible will his estate could have sold the property and possibly used up the gain.

Another reason to use up capital losses is their benefits with debt recycling. Making capital gains without needing to pay tax will mean there is more money with which the non-deductible debt can be reduced.


Example of Debt Recycling

Lisa has a $100,000 capital loss from some bad share investments many years ago. Because of this she has a large amount of debt still outstanding on her main residence. But this has not stopped her investing in shares again. She has learnt from her mistakes and is now making some good capital gains.

If Lisa’s shares increased in value by, say $20,000 in the first year, she could sell these shares, pay no tax, and use the proceeds to pay down the non-deductible debt, and then invest in more shares and repeat.

Doing this has 2 advantages

  1. It uses up the loss, and
  2. It produces tax free capital gains which can then be used to pay off the non-deductible debt quicker.

Speak to your tax lawyer or tax agent.

An Example of How poor Ownership Structuring Can be Painful.

Homer and Marge own 5 investment properties all jointly as Joint Tenants. All in NSW and with a combined land value of $1,200,000.

Homer is on the top marginal tax rate and Marge doesn’t work.

They have reached their borrowing capacity.

They have just paid off their main residence and are saving about $10,000 per month.

Issues

  1. Land tax

Combined land tax is $9,236 (2018 year)

If they have owned $600,000 worth of land each then there would be no land tax

  • CGT

If they sell any investment property 50% of the gain will go to Homer. They can’t divert the income to Marge.

  • Paying Down Debt

They have excess cash, ideally this would applied to Marge’s debt as she would pay less tax. But as all the loans are joint they are stuck with reducing the debt relating to both Homer and Marge

  • Offset Accounts

Similar with the cash savings/buffer. It must go into an offset account liked to a joint loan so Homer’s income will increase.

Death Planning

Because they own everything as joint tenants if one dies there is no opportunity to get half of the assets into a testamentary discretionary trust. This will result in extra tax being payable after the death of one of them.

Possible Solutions?

As they have reached their borrowing cap there may not be much they can do if they cannot qualify for a loan. But they could consider

  1. Spouse A selling 50% of the property to Spouse B.
  2. Selling on property and buying a replacement in Marge’s name only
  3. Save up and lend cash to a trustee of a discretionary trust which will buy property and then divert the rental income to Marge
  4. Sever the Joint Tenancy so they hold the existing properties as Tenants in Common in equal shares – no duty, no CGT and easy to do without triggering a loan reassessment. They could then each leave their shares of the properties to the trustee of a testamentary discretionary trust controlled by the other spouse. Half the rents could then be streamed to the children potentially tax free.
  5. Etc

Tax Tip: The effect of Taking a Year off Work to Save CGT

If someone sells a property and has a large capital gain is it worthwhile taking a whole year off work to save tax? In my view it is always great to take a year off work, but it might not actually save you that much tax.

Example

Richie Rich is about to sell an investment property with a $200,000 capital gain. He is sick of it under performing and draining him with land taxand has a low yield. Richie is toying with the idea of taking a whole year off work to save CGT. Is it worth it?

Let’s assume Richie earns $100,000 in his job, and the sale will happen in the 2018-2019 financial year.

If he sells the $200,000 gain will be reduced to $100,000(due to holding it longer than 12 months) and added to his other income for the tax year. The result is an annual income of $200,000

Tax on $100,000                   $26,117          Net income   $73,883

Tax on $200,000                   $67,097          Net income   $132,903

Difference                              $40,980          Difference      $59,020

The Capital Gain will mean $40,980 in extra tax payable for the year.

This means by giving up a year’s income from work Richie would only earn $100,000 from the capital gain. Therefore, he will save $40,980 in tax by not working.

But not working means he has less income, working the full year in which the sale occurs will net him only $59,020 as opposed to his normal $73,883 (a difference of $14,863).

He would need to determine if the effort of working is worth the pay cut of $14,863 which is about $286 per week.

He should also factor in transport costs to work and other work-related costs – clothing, lunches etc.  and there are also heaps of non-financial things to consider. There would be time to do other things such as:

  • Start a business
  • Travel
  • Study
  • relax

Written by Terry Waugh of www.structuringlawyers.com.au

The Pleasures of CGT: 5 Reasons Why CGT is better than Income Tax

It is not often that you use the words ‘pleasure’ and ‘tax’ in the same sentence, but if you had a choice of income tax or Capital Gains Tax (CGT) it would be more pleasurable to pay CGT.

Here’s why:

1. CGT Tax is only payable at the end so greater compounding during the life of the investment

Example

2 investments of $100,000:

A. one returning 0% income with 10% capital gains, or

B. One returning 10% income with 0% capital gains.

Same overall return but different tax consequences.

 

In year 1

A will be worth $110,000 but no tax payable yet,

B will be worth $100,000 with income of $10,000 so up to nearly $5,000 lost in tax.

 

In year 2

A will be worth $121,000

B will be worth $105,00

Each returning the same 10% again.

If this continues the gap between A and B will widen each year.

 

2. Can be avoided completely on at least one and possibly 2 properties

The main residence exemption means one asset can be completely tax free. Careful planning can allow for 2 properties to be totally exempt for the whole ownership period.

3. The 50% CGT discount

Once the tax is payable most taxpayers will actually get a 50% reduction in the tax payable because of the 50% CGT discount. This applies for assets held longer than 12 months. It doesn’t apply to income received more than 12 months!

 

4. Personal expenses can reduce it

Move into an investment property and costs incurred while living in the property can be used to reduce the eventual CGT – potentially to nil. These are the 3rd element cost base expenses and include interest, rates, repairs, insurances etc. You can’t do this with income.

 

5. Time to Plan

CGT can be minimised by careful planning. This can involve timing strategies, bringing forward other expenses and other strategies some of which I have outlined at: Tax Tip 119: How to Reduce CGT on Investment Property (Part I)            https://propertychat.com.au/community/threads/tax-tip-119-how-to-reduce-cgt-on-investment-property-part-i.10681/

 

Written by Terry Waugh, solicitor at www.structuringlawyers.com.au

Don’t rely on a lender’s valuation for CGT

When a property first becomes income producing the cost base is reset to the value at the date it becomes income producing.

Many people want to save a few hundred dollars by not ordering a valuation, but rather rely on a bank’s valuation. This could be potentially costing them  thousands of dollars.

Example

Ned moves out of his property and gets his broker to order a bank valuation which comes in at $475,000. Ned thinks this is a bit low and asks for another valuation, but the bank refuses and so he doesn’t really think about it any further.

Maude, Ned’s wife, orders a private valuation for tax purposes which comes in at $500,000.  When the property is later sold for $600,000 there will be a difference in the cost base:

  • 1st Valuation will make the gain to be $125,000
  • 2nd valuation will make the gain to be $100,000Applying the 50% CGT discount these become: $62,500, or $50,000
    Added on to their marginal tax rates of 39%: $24,375 in CGT or $19,500
    Taking the time to order a second valuation has resulted in a tax saving of $4,875.

Not bad tax saving when the advice only cost $660!

 

This article was written by Terryw from:

www.structuringlawyers.com.au