Offsetting rental loss - advantage of not having house in trust?

[Bean]

hello,

I have been advised to put my house into a Family Trust. However there is an advantage of not having it in a Trust that I can see. I have had rental income from the house previously and intend to again. When it was rented there were maintenance and repairs expenses and the house made a loss. For tax, the loss was offset against my income as an employee, so the amount of the loss was income that I did not have to pay tax on, not an insubstantial amount. If the house was in a Trust I would not be able to do that as the Trust is a separate legal entity.

If I was not an employee, but had a limited company, then both the company and the house could be in the Trust and if there was a rental loss it could be offset against the company income. However, with the house not in a Trust, even with a company rather than being an employee, the rental loss could still be offset against income. So it seems to me, for the puposes of rental loss, that it is better not to have the house in a Trust unless expecting any financial attacks on the property.

The house does need alot of maintenance and repair and so it will most likely run at a rental loss.

Am I right in this?

Bean

[essence]

Bean,

For the purposes of a rental loss, you are correct. The losses can be distributed to the owners (company or individual) but only as a proportion of the shares they own.

If a property in a Trust makes a "loss" ie maintenance/depreciation exceed income, then yes the loss stays with the Trust. This accumulates as tax credits. When the property in the Trust starts making a "income", then tax credits are used to offset the income. Makes sense?

This whole situation depends on whether you want asset protection or income reduction. And only your situation can determine that.

Re financial attacks on the property. By the time you've got a problem, it's too late to put it into a Trust!!

[Rosco]

If you are thinking about a Trust, you need to look at the benefits vs costs.

For the benefits, what does asset protection really mean for you? What are you protecting from and what is the likelihood of this happening? What is your real risk.

For some people, they have high risks and it makes sense for them to protect their assets using a Trust. But for many normal people, it is hard to get a real benefit, ie
- Protect from partner - A Trust isn't guaranteed to do this. More a legal question, but my understanding is a pre-nup is better
- Avoid rest home fees - There is a similar thread on this that I researched into, and under 10% of people go into rest homes. Plus how many years away are you looking at this, and if for example 40-50 years, do you really think the government won't have reconsidered trusts by then, or had to stop rest home subsidies anyway?
- Trust changes - Trust are getting reviewed, so could change

Yes a Trust has costs and one is the inability to offset losses against personal income. But with no more building depreciation, most investors should be trying to turn their investment properties positive. A rental making a profit works well in a Trust, as you have more ability to allocate the income. If you have a business, then there are structures where you can get the rental loss offsetting the business profits, plus get asset protection.

Some investors like to have losses built up in a Trust, so that later in life there rental income is tax free.

Personally, if there is a reasonable loss (think interest rates increasing at some point) then I like to be able to offset this loss against other income, giving a tax refund or less tax to pay.

Ross

[Perry]

Half A Mo'

I have been advised to put my house into a Family Trust.

Who by? What were the reasons given?

If the house was in a Trust I would not be able to do
that [offset losses] as a Trust is a separate legal entity.

Not directly, but the Trust could lease the rental to
Mr Bean and Mr Bean could rent to tenants. Just be
sure to keep the various payments credible.

BTW - a Trust is not a legal entity. It's more often re-
ferred to as a legal obligation. So, the trustee's names
will appear on the CoT. E.g. Shes Bean and Hes Bean
and Has Bean, rather than the 'Bean Family Trust.'

Ivan's recent mention of 'power of appointment' in
relation to Trusts, Trustees and bankruptcy does seem
to affirm more strongly the need for a corporate
trustee coy, BTW.

All of which adds to costs, as Ross observes.

[Rosco]

Not directly, but the Trust could lease the rental to
Mr Bean and Mr Bean could rent to tenants. Just be
sure to keep the various payments credible.

Be very careful of this. Some lawyers promote this structure and I think it is just a load of rubbish. If IRD didn't look at this as tax evasion, then there would have to be something wrong with them.

How I have seen this happen or be suggested.

Trust owns property.
Trust rents to individual or LTC for say $400 per week. This means the Trust covers its costs. Long term lease maybe 5 years and in some cases the individual or LTC pays the rates and insurance, like in a commercial lease.
Individual or LTC then rents normally to the public. Might get $250 per week. So makes a loss of $150 per week, that is normally offset against other income.

So this structure gets the property owned by the trust, so asset protection. But also gets the loss in the individuals name, so ticks both boxexs.

BUT - look at this from a commercial perspective, would any sane person be the middle man if unrelated? ie pay $400 per week, when they could only rent for $250 per week? NO. So this scheme or structure is merely set up for tax purposes and very dodgy ones at that.

Ross

[Perry]

While I affirmed that payments have to be credible, I don't agree
that the arrangement described are implicitly tax avoidance.
Nor do I agree with Ross' comment that it's a load of rubbish.
There are many valid commercial reasons for such a structure.
Just be sure you have one and can demonstrate it.

[Rosco]

There are many valid commercial reasons for such a structure.
Just be sure you have one and can demonstrate it.

Hi Perry,

I've been trying to think of a commercial reason for doing this. I can't think of one reason, and maybe you can help?

If you want asset protection, then why not just own in the Trust and rent from the Trust? This makes sense, and saves unnecessary paper work, admin time and other costs.

More on asset protection, if you are worried about tenants suing, OSH etc. Risk of running a rental property is extremely low. I don't know of any cases where a landlord has been sued. Even if the landlord was sued, the owner would most likely be included in the proceedings, so your stucture wouldn't give any additional benefit. I know of a commercial situation where this is happening, the tenant is causing the possible issues, but the owner is being involved in the court proceedings.

Apart from tax, I can't think of any reasonable reason for doing this.

Ross

[Perry]

I've been trying to think of a commercial reason for doing this.
I can't think of one reason, and maybe you can help?

If you want asset protection, then why not just own in the
Trust and rent from the Trust? This makes sense, and saves
unnecessary paper work, admin time and other costs.

One would be that the TT Kangaroo Kourt now has
the power to make orders against LLs up to $50k.
(RTA s 77 - Jurisdiction of Tribunal)

Which could be seen as in the same general category that
you refer to here . . .

More on asset protection, if you are worried about tenants
suing, OSH etc. Risk of running a rental property is extremely
low. I don't know of any cases where a landlord has been
sued. Even if the landlord was sued, the owner would most
likely be included in the proceedings, so your structure
wouldn't give any additional benefit. I know of a commercial
situation where this is happening, the tenant is causing the
possible issues, but the owner is being involved in the
court proceedings.

Joining other entities in a legal action is common. Whether
or not there is any merit in that is moot. Depends on the
circumstances.

The arrangement I describe of one entity holding the property
and another entity being the LL is my preference and has been
that way for many years. I.e. nothing to do with anything new
in vogue with lawyers or otherwise. Well, apart from the $50k
bit post-dating that choice. But that only confirmed my view.

Similar, but even more complicated commercial structures
are very common, as I understand it.

I was recently looking at the structure of the big electricity
gobbler down in Shadbolt country. It is/was the usual tangled
web of corporate entities, including:
NZAS (NZ Aluminium Smelters)
Comalco Ind Pty Australia
Comalco Power Ltd
Sumitomo Chemical Co Japan
Showa Denko Japan
Conzinc Rio Tinto Australia
Rio Tinto Zinc Corp . . .

Comalco Ind Pty Australia buys the power to run its NZAS
smelters from its own subsidiary Comalco Power Ltd, which
buys the necessary watts from Meridian. (All as far as I can
tell - it's a bit of a tortuous web.)

Would that be tax avoidance? Who's to know?

BTW. You're not alone - my accountant was not initially in
favour of that set-up, either.

If one does most of the paperwork and admin oneself, it's
not too onerous or expensive. But if one was paying some
one else to do it, yes, it could be quite cost-inefficient.

[sidinz]

Disclaimer: I have not had the following legally verified, so you may want to.

My home is in a Trust. It is set up so that I have the exclusive right to occupy the property, and I am responsible for mortgage interest, rates, insurance, repairs etc. (Others are set up differently - it's all in how you word the Trust Deed.)

So when I went overseas for work, I, personally, rented it out rather than the Trust. This made things a lot simpler. I received the rents, I deducted the expenses that I was liable for and depreciation on MY chattels etc., etc. It also meant that I could claim losses against other income. I also claimed losses from my (then) LAQC.

So perhaps this is a way to structure things, if you set up the Trust in such a way that it is made clear that you have exclusive right to inhabit/benefit from the property, but have the right to rent it out (to cover costs) if at any time you do not need it.

BTW - a Trust is not a legal entity. It's more often referred to as a legal obligation. So, the trustee's names will appear on the CoT. E.g. Shes Bean and Hes Bean and Has Bean, rather than the 'Bean Family Trust.'

Or, like mine, your Trust could have a trustee company instead, which gives you greater flexibility. Changing or adding trustees is as simple as appointing someone as a director in the company.

[Rosco]

Hi Perry,

does the middle entity make a loss? If no loss then no tax problem.

but if makes a loss, I still can't see why an entity would want to do this, except for tax. Ie middle entity makes loss, incurs TT Kangaroo Court risk etc, and I can't see any upside. If unrelated, why would any entity do this?

Going back to your first post about owning in a Trust but getting tax loss in personal name, still doesn't make sense or stand up to a reasonable person test.

Ross

[Perry]

Does the middle entity make a loss?

Depends on the year.

But if makes a loss, I still can't see why an entity would want to do this,
except for tax. I.e. middle entity makes loss, incurs TT Kangaroo Court risk
etc, and I can't see any upside. If unrelated, why would any entity do this?

Avoiding the possible prospect of a $50k order is not an upside?

Going back to your first post about owning in a Trust but getting tax loss in
personal name, still doesn't make sense or stand up to a reasonable person test.

Liability minimisation seems to me to be a valid reason. And if there's
a certain side effect, well, golly-gosh. Besides, it's vaguely analogous
to a back-to-back loan. The loss (if any) is still somewhere and can
still be offset against income. Just which entity and when could be
a moot point. Given the trustee income tax rates, it may be tax-
advantageous from an IRD perspective to have it in an entity in-
between tenants & Trust. That would depend on their respective
income tax rates.

If it could be proven that the set-up was contrived with the intention
of creating a tax loss, then I agree with you.

PS
In my case, the Trust existed before the rentals did.

[speights boy]

The first vague principle is the “general anti-avoidance rule”, or GAAR, which states in essence that even if a citizen meets all the specific provisions of the tax law, Inland Revenue has the power to accuse the citizen of tax avoidance if an arrangement appears to have tax avoidance as its main purpose or effect – that is, it is not an incidental purpose or effect.

Once the Inland Revenue invokes that rule against a citizen, the onus is then on the citizen to demonstrate the IRD is wrong.

The doctrine states – and was restated this week by Justice Rhys Harrison in the Alesco case – that a citizen accused of tax avoidance “must satisfy the court that the use made of the specific provision is within its intended scope”.

That is, that the citizen has to prove he/she has used the relevant tax provision in a way Parliament intended when it made that particular law.

To put it another way: “It's just the vibe, citizen taxpayer – so pay up.”

www.nbr.co.nz/article/tax-avoidance-its-just-vibe-says-court-appeal-weekend-review-rh-13

[Perry]

The Slippery Slope

That is, that the citizen has to prove he/she has used the relevant tax provision
in a way Parliament intended when it made that particular law.

That, along with the Penny & Hooper case, is the slippery slope that leads
to anarchy and a total disrespect for the law. Let us dump the expression
"tax provision" and replace it with the word 'law.' There is no valid reason
why a law primarily concerned with 'taxation' should merit separate and
discrete judicial treatment from any other statute.

A citizen must (in my view) comply with the law as written. If the citizen is
placed in the position of speculating on what parliament intended, as opp-
osed to what parliament wrote and adopted into law, then that is an impos-
sible situation. Although some forumites dismiss the concept of compliance
with the law as written as "outdated jurisprudence," it has been used suc-
cessfully in previous cases in NZ, as many precedents confirm.

In the past, (pre Penny & Hooper) the judiciary has made it plain that it is
the court's job to interpret the law as written; not to guess as what was
or may have been intended. I.e. if parliament cannot write laws to mean
what was intended, it's not the courts task to remedy that. No other way
is tenable, in my view.

As an egregious example, imagine that you were convicted for using your
vehicle at a speed of 44kpm in a 50kph area, on the basis that it was
parliament's intention to promote safety on the roads when it legislated
that speed limit of 50kph?

[NomoneyNotalk]

hi,

my accountant advised me to put houses that are making profits into trust, and the ones making loss into company.

Personally i think trust is best for rental properties. That house would eventually be making profit once the repairs are done. You wouldn't wanna keep properties that don't give you any return

[Rosco]

Hi Perry,

Just looking at your middle entity, why would any sane person be this? Take on the risk, plus lose money?

I think it would have to work like this , to make your argument work

- Trust rents for say $250 per week, long term rental agreement of say 5 years
- Company or individual(middle person), then takes on risk, and rents from Trust for this period.
- Company or individual then on rents to tenant for say $300 to $400 per week. So then the middle person is getting a return for their risk. Also if rents go up, they would get a further benefit.

Then your Trust is getting full protection. But the middle part then makes commercial sense. I would personally think the middle entity would need $100 per week to take on the hassle and risk.

Doesn't matter if your Trust was set up first or not. It's the issues with the overall arrangement and especially the logic of the middle entity that would concern me.

If you were just doing this for asset protection you other options could be
- rentals in Company owned by Trust
- rentals in a seperate Trust

Ross