Entities for trading and buy and holds

[moovet]

Hi,

Changed my accountant yesterday and had a session with him to sort out entities for trading and buy and hold. Currently we have 2 rentals in a LAQC we intend to hold. We would also like to be able to trade if opportunities arise. THis was his proposal and I was just after comments as to whether it sounded OK to you guys that do a bit of it.

A trading trust with a corporate trustee and a family trust as a beneficiary. Keep the LAQC and sell shares to family trust when all in portfolio beomes positive pretax cashflow. Have separate LAQC's for each bank properties are mortgaged with.

So for trading I will have a trading trust and the same family trust as a beneficiary as the buy and hold properties that are pretax cashflow positive. Positive aftertax cashflow properties will be held in an LAQC till they become positive pretax. Hopefully that allows me to still buy rentals and flick a few do ups as well. I am finding it hard to create positive pretax cashflows in the market at the moment so a few trades may help increase my equity in the meantime.

As always your comments are much appreciated

G

[drelly]

Sounds good to me. Just beware of capital growth in your LAQC as you may only gift $27,000 a year to your trust.

Also remember that without adhering to the function (or rules) of your structure, the form of it is worthless. Do a questionable deal within your LAQC and no amount of money spent on structuring will protect you come audit time.

My accountant believes that there is no legal protection from "tainting" ie; we as individuals will always be associated with a trading entity regardless of how we structure it. But as long as we play by the rules, the structure reinforces the separation from buy and hold investments.

cheers,
Dave.

[Dean@Massiveaction]

Your accountants advice is what most of us are doing. One small concern for us all is that IRD are currently challenging the LAQC structure when one transfers the shares to the family trust, as tax avoidance. Garth and Kenina and others are tending to recommend to people to forget LAQC's and move to rental trusts in case this IRD challenge becomes law. SO if you were really risk averse and didn't need the tax offset against your PAYE, you could bypass the LAQC and go straight to a trust structure for your buy and holds.

[cube]

LAQCs are good if you need the cashflow now - if you can wait, then holding the rentals in a trust just allows the losses to build up until they become profitable, and then the losses can be offset against the gains, reducing tax later, rather than now.

[drelly]

Hey Dean,

Have you had any indication what will happen to existing LAQC's that have been transferred to trusts?

cheers,
Dave.

[xris]

Hello moovet,

Please take this as an opinion only. No doubt there will be other opinions coming.

I feel uneasy about this plan.

Moving long-term rentals from an LAQC to a trust when they become cash-flow positive? I thought it was now well established that that is too risky and the
IRD will not accept it. I am a little surprised that you received that advice.

Also, I feel a twinge of discomfort at having your LAQCs transfer funds direct to the family trust, although I have not properly thought this through yet. There is just something about it that makes me hesitate.

Also, why have separate LAQCs for both rentals just because the rentals have mortgages with different banks. Again, maybe there is something obvious here that I am overlooking, but I cannot immediately see what it is.

An interesting thread which I will enjoy following.

xris

[Dean@Massiveaction]

Hi Dave, haven't got a clue but in theory if already done then no issue. Potentially every LAQC where the shareholding changes at the same time it starts to show a profit could be targeted. I know several property accountants think it will happen and there are a couple of people being taken to court over it at the moment. Advice is to get the shareholding changed now irrespective of how big your losses are so you will be under the radar if it becomes an issue.

[drelly]

I was thinking the same for my LAQC and will be discussing it with the beancounter next week. How long is it likely to be before there's a ruling on the IRD challenge?

[Dean@Massiveaction]

No idea. I'm going to have to look at it as well shortly. Although my accountant is less concerned. He thinks IRD will back off??

[CJ]

YOur advice sounds about right. Two issues have been raised.

1. why a new LAQC for each bank. There is no specific reason for this that I can think of.

2. Transfer of LAQC. This has two problems. If the value of the company has increased, it will take a while to gift it. It must be transfered at market value. there is also a risk of tax avoidance. why are you transfering to a trust. the timing stinks of tax avoidance. you need to have a commercial reason to be doing it at that time. If you say you are doing it for asset protection, why didn't you do it when you first established the trust - why wait until the tax beneifts end??

a couple of people being taken to court over it at the moment.

I keep seeing people saying this (on a number of issue re LAQC's) though have never heard of a decision from the courts. Is everyone settling before trial or is this just urban myths trying to scare people.

I think the IRD and the govenerment will be looking at LAQC generally to see if they can counter the housing cycle (since interest rates aren't stopping it). I haven't heard any rumours though.

[moovet]

The suggestion was made by the accountant I think in terms of asset protection. I think the reasoning behind a different LAQC for each bank was that if you are borrowing against equity in an existing property with that bank you have less liability with others in your portfolio with other banks if things go wrong. I think that was the jist. Also some banks may have a limit as to your borrowing and if you start afresh with a new bank and new LAQC if your lender refuses to lend more.

Lots of "I thinks" there I know but those were the reasons

G

[masteraccountants]

Back from holidays

Hi,

I've been away over the festive season, and have got back in the saddle now. The ideas being bandied around in this topic are interesting, so maybe it's time to add a few comments.

The advice about having several LAQCs for properties being financed by different banks can seem to be self-serving for accountants. The more LAQCs that we set up for you make money for us in the setting up of them and in the preparing of accounts for them.

I do not recommend it to my clients, but I do discuss the issue when it appears to be important to particular clients.

If you have different LAQCs for properties financed by different banks, then you can offer less collateral over the properties to different banks. This may mean that you can borrow more money and/or release certain properties from mortgages.

Another reason is asset protection, as mentioned by one of the other contributors. Let's say that one of your tenants or their visitors has a bad accident in your rented property. Le'ts say that you are found to have been negligent and the Court or ACC pursues you for more than your insurance coverage. And let's say that you have more than one property in the LAQC that owns that particular property. You could end up losing more than if only one property were in that LAQC.

On the issue of selling the shares in an LAQC to a Trust, IRD will accept an argument that the objective is asset protection where the shareholders in the company are the same as the beneficiaries in the Trust. Where there are different or more beneficiaries in the Trust than there are shareholders in the company, then IRD could see that there might be another aim, such as tax minimisation through income sharing with taxpayers of lower marginal tax rates.

There are ways of gaining taxation benefits from Trusts through suitably worded property management agreements between the Trust and the persons willing to accept the role of property managers. So LAQCs are not the only option.

If the sale of a property from an LAQC to a Trust involves the Trust owing money to the LAQC, it is not possible for the LAQC to "forgive" the debt of the Trust, as it cannot be said to bear "natural love and affection" for the Trust or the beneficiaries of the Trust. Care needs to be taken if the property sale results in a loan from the company to the Trust.

Tainting is a real issue. There are ways to achieve sufficient 'dissociation' between a trading company and a property owning Trust, so that you can engage in property owning and property trading. This is based on a legal precendent and CCH opinion. The other way around of having a trading Trust and a property owning LAQC is very ahrd to engineer, as there are not many people prepared to be an independent trustee of a trading Trust.

We've covered a lot of ground. But I have covered these issues in other threads.