Trust for home and LTC for rental best structure?

[mattp]

Hi there,

Current situation for myself and partner:

Home: market value 500,000 with mortgage of 100000
1 Rental: market value 300,000 with mortgage of 200000

The question is what is the best tax/ownership structure? I'm told that it would be good to set up a Family Trust for our home and set up a LTC for a rental.
Then debt is then transferred from the Trust to the to the LTC thereby decreasing the amount of debt in our home and increasing the amount of debt in the rental:

For example:

Family Trust: market value 500,000 with no mortgage.
LTC with mortgage of 300,000.

Is this a good idea? Am a investment newbie unfamiliar with Trust and debt transfer.

Appreciate any advice

[Rosco]

Hi Matt,

There are lots of different factors that affect which is the best structure for you.

Trusts are going through a period of change at the moment, so you need to consider how important it is to have a Trust now, or whether you can wait a few years while the changes settle down, and then form one. Otherwise there is a risk of forming a Trust now for X purpose, only to find the rules change and that purpose is not longer relevant.

What is the main reason you are looking at forming a Trust? ie what benefit does a Trust give you?
Generally part of this is around asset protection, so you need to consider, "what are you protecting from?", "what is your risk?", "what is your worst case scenario?"

A Trust will cost you at least $5,000 to set up overall (form Trust, update wills, power of attorneys, memorandum of wishes, independent Trustee, legal sale from personal names to Trust, gifting) and then ongoing administration costs, costs of an independent Trustee and annual set of financial statements. So you need to ensure the benefit you are receiving is more than the costs!

If you are looking at setting up a Trust for asset protection, then if protection is very important to you, or you are high risk (director of big firm, trustee, public advice given, risky industry, PG's given for work, etc) then really your rental should be in the Trust as well. Big disadvantage to Trusts for many, is that if rental is negative, the losses are stuck within the Trust and cannot offset personal income.

If you own a business, then there are other structures available that can give you asset protection and tax benefits.

It is not the Trust and LTC that give the extra tax benefit through debt transfer. It is just a restructure to a new entity (could be LTC or Trust), so you don't need to set up a Trust for this to work. Just be careful this is done correctly.

When looking at the structure for a rental, you also need to look at cost vs benefit. Changing to an LTC could cause depreciation recovery, could be loan break fees, will be legal costs to buy and sell etc, so you need to make sure the extra tax benefits obtained out weigh these costs. If you are considering selling in the next year or two, it is probably better to keep things as they are.

For the rental structure, how positive or negative the rental is can make a big difference. An LTC or Trust or other structures have different pro's and cons depending on your situaiton.

Hope this gives you a start, and overall you need to seek expert advice from a property accountant. We have a great offer for investors new to property that you can check out on our website.

Ross

[Perry]

A Trust will cost you at least $5,000 to set up overall . . .

There may be less expensive ways of doing that, of course. Apart from
that qualification / observation, however, this is sound counsel:

So you need to ensure the benefit you are receiving is more than the costs!

A provided further however is that . . .
a Trust is not confined to asset protection as its reason for being.
Estate planning is an aspect of a Trust that can have many things
to commend it. One is sometimes referred to as "reaching from the
grave."

Nothing particularly macabre about that, though. One possible
example is preventing a known spendthrift beneficiary from blowing
what might otherwise be a Will bequest, in very short order. Having
the oversight / stewardship of trustees can often manage that in
a much more appropriate fashion.

[Rosco]

Re the set up costs. We don't set up Trusts, and lawyers would normally set up a Trust.

- Trust establishment $1500 to $2000. Anything cheaper than this, I would consider cheap and nasty
- Selling Property from personal names, say $1200 (legal fees)
- Buying Property into Trust (legal fees) another $1200
- Wills, $500 to $1000?
- Power of Attorney? $500
- Memorandum of Wishes $500
- Professional Trustee - $75 to $500
- Gifting $250
- Advice about administrating Trust, and advice about setting up at the start - $500 to $1000
- Corporate Trustee? $500

Total $6,725

Ross

[Rosco]

Reaching from the Grave - This is another benefit, but just be aware for many Trusts it never actually works out that way.

Ie Mum and Dad set up Trust to hold assets and protect it for the future.

Mum and Dad die. The children then normally become Trustees along with a professional advisor.

Children(I'm really thinking in there 40-50, not youngsters) then convince professional advisor to wind up Trust.

Often these Trusts are wound up, with children getting the money. So you need to consider carefully, what is really going to happen after death.


Ross

[BigBadWolf]

We have just established another company to run our family trust (which owns a large business, as well as significant real estate consisting of residential property and farmland). The reason for doing this was to prevent the situation Ross describes occuring, Ie one trustee wanting to cash out their share, requiring large amounts of assets to be sold at the expense of the business and trust as a whole.

[Perry]

Reaching from the Grave - That is another benefit, but just be aware for many
Trusts it never actually works out that way. The children then normally become
Trustees along with a professional advisor.

If that's normal, it's not my normal. I have ensured that (e.g.) my parents
have appointed replacement Trustees for their Trust, in their Wills, along
with a MoW to be provided to any Trustees so appointed. Having children
as trustees at any stage is a potentially fraught situation & to be avoided.

[Rosco]

But who has the power of appointment?

One situation I have seen is that a family member held the power of appointment, so could appoint the children, or remove a professional trustee if they weren't agreeing to wind up the Trust.

I'm not saying the Trust can't protect children after the death of the parents, but it does need some careful
consideration. For example MoW aren't legally binding.

Ross

[Perry]

It's reasonably basic stuff, Ross. Correspondingly so with removing trustees. E.g. . . .

13. POWER TO APPOINT NEW TRUSTEES
a. The statutory power of appointment of new Trustees hereof shall be vested
in Ma and Pa during their lifetime and thereafter shall be vested in the person
or persons as Ma and Pa may by Will nominate for the purpose and if there is
no such person capable of or willing to exercise such power then . . .

For example MoW aren't legally binding.

As well as not being binding, MoWs are privileged / non-discoverable, AFAIK.
To avoid making life too difficult for such appointed Trustees, a good M0W is
also a guide, rather than being awkwardly prescriptive.

[Rosco]

Hi Perry,

What I was trying to say, was often parents pass their power of appointment to their children. Once the children have this, they could then appoint themselves as Trustee's, remove existing Trustee's and gain full control.

Ross

[Bob Kane]

Which makes me wonder why have a trust?
If the kids are honourable then they'll protect and grow the family wealth.
If the kids want the money then they'll get their hands on it (one way or another) and spend it.
The trust doesn't actually protect the family wealth from the kids.
I guess a trust protects the wealth from creditors claims which must be why all the rich dodgy people have them.

[Rosco]

Hi Bob,

It's not just for rich dodgy people. An example

- A farmer's employee hates ticks, and drenches the cows with xxxxxxx (I'm not a farmer anymore and can't remember the exact details of the case) to stop them
- The employee does this without the farmer being aware and does not inform Fonterra
- This contaminates the milk supply
- This isn't picked up in the tanker or factory
- The contamination gets as far as China before being picked up. This then has major impact on the China market, plus means the entire batch worth say $1 million needs to be destroyed. PR in China required etc. Overall cost say $2 million

I can't remember the outcome of this case, but the farmer could well be liable for this full $2 million. Insurance could cover, but then again insurance can't cover everything.

In this situation, operating through a well designed structure and having a Trust could protect the farm from the claim. It might mean the individual farmer has to go bankrupt still.


So a Trust can help to protect against a left-field event happening, and protect your wealth. It can protect an honest person from a major issue.

Also it is worth bearing in mind the bankruptcy comment earlier. If you have all your assets in a Trust, but you are sued and don't want to go bankrupt. Then you would need to use the Trust assets to pay the debt. This kind of undoes the whole purpose of the Trust!

Ross

[Perry]

Also it is worth bearing in mind the bankruptcy comment earlier. If you have all
your assets in a Trust, but you are sued and don't want to go bankrupt, then
you would need to use the Trust assets to pay the debt. This kind of undoes
the whole purpose of the Trust!

Perhaps you could furnish some additional information about that? It does
seem to be at odds with legal practice / tradition as provided for in the
provisions in the Insolvency Act. So I suspect that some legislative changes
would have been necessary for what you describe to occur.

[Ivan McIntosh]

It just means that in practice, the trust is holding assets that creditors of you personally can't get a hold of.

But if you want to avoid having them bankrupt you, often the trust will have to stump up some cash.

Had quite an indignant client a decade back wanting to know why his trust was not protecting him, in that the trust owned family home was being sold in order to pay his personal debt so that he wouldn't go bankrupt. Whereas in reality the trust was perfectly good...it was just that he didn't want to be bankrupt and the trustees (who were himself and his spouse and did not include us) were rolling over and selling everything to ensure he didn't. What was the use of having the trust, he asked?

Well, the "use" was that, if his debt had been too large to be satisfied by the sale of trust assets or he simply didn't want to pay it, he would have been bankrupted but still through the trust retained the use of the family home. In three years time he would have been able to start again using the trust property as security. It just so happened that he considered he would make more if he stayed unbankrupted, and his creditors were no doubt relieved to hear it.

Anyway. Trusts are, in my opinion, essential for business people, and even better if you can keep them very lowly geared or mortgage free, while acknowledging that is difficult. For others, not so much unless you can keep them mortgage free....then they are a haven in the event that the rest of your activities fail.

LTC's tend to be best for properties that may run at a loss. If they are not running at a loss, then do examine carefully with your accountant whether there is any good point in restructuring and how, particularly with depreciation recovery, and whether it would be better to insulate the shares in the companies from your personal ownership (usually if you've given personal guarantees there is no real point in worrying about this, but having income flow to personal shareholders might be tax inefficient). There are so many variables it is difficult to put them all in a forum post.

[Wayne]

What was the use of having the trust, he asked?

"No use at all", you replied, "if you are too stupid to use it as intended."