Astute investors assess many options in choosing a structure for investment, with tax planning being one consideration among many.
There are tax advantages in relation to using a discretionary family trust or a self-managed superannuation fund (SMSF). However, one question that needs to be answered by investors is: “When do you wish to realise any profits from the property?”
For those who wish to retire in the lap of luxury, betting on longevity and good health, then a SMSF could be suitable.
Conversely, for those living for the now and with a large family, a discretionary trust arrangement where the wealth can be immediately shared is typically preferred.
So what are the pros and cons of each type of structure for property investment? The following may answer many questions.
SMSF v Discretionary trust
|Discretionary trust||Setting up a trust can be fairly inexpensive, as a standard discretionary trust deed can be purchased online from a provider such as “ClearDocs”. Additional expenses may be incurred by using a corporate trustee, however, the total cost of establishing
a discretionary trust would generally be around the $3,000 mark.
|If you wish to keep set-up costs down then a discretionary trust would be the preferred vehicle.|
|SMSF||Setting up an SMSF will be more expensive. If you wish to borrow for your property investment, you would also need to set up a bare trust. Further, with the new requirements for SMSF advisers to be compliant by obtaining an Australian Financial Services License, these additional registration costs will be reflected through increased adviser fees. Expect costs to be upwards of $8,000 to get things started.|
|Discretionary trust||Ongoing costs for a trust would include the completion of special purpose financial accounts and lodging tax returns. A cost of about $1,000 should see you through with the basics.||Compliance costs associated with SMSFs are greater, but generous tax concessions exist (see below).|
|SMSF||With an SMSF, you will need to complete financial reports which also includes an audit of those accounts, as well as the preparation of income tax returns, so about $4,000 should get you over the line.|
|Borrowings and redraws|
|Discretionary trust||In a discretionary trust there are no limits to borrowing, except from your financial institution. There is also the ability to re-draw excess funds from the facility (provided the facility offers this).||A discretionary trust provides greater flexibility in borrowing and redrawing equity for personal use.|
|SMSF||With an SMSF, you are limited to using a limited resource borrowing arrangement. Further, redraw of borrowings for SMSFs is not permitted. The only way funds can be realised is by selling the property and starting again.|
|Taxation on income and capital gains|
|Discretionary trust||Taxed at marginal rate if beneficiaries made presently entitled to the income are individuals, 30% if distributed to a corporate beneficiary; otherwise any undistributed income is taxed to the trustee at the top marginal rate.
Individuals can take advantage of the tax-free threshold – however, this is not available for distributions made to minors.
The general discount for capital gains is 50% if gains are distributed to eligible beneficiaries.
|An SMSF provides more generous tax concessions relative to a discretionary trust.|
|SMSF||During accumulation phase, a SMSF is taxed at a rate of 15%.
No tax is payable for pensions paid when the fund is in pension phase.
The general discount for capital gains is 33 1/3% instead of 50%.
|Access to funds|
|Discretionary trust||In poker parlance, with a discretionary trust you can have total control over when you want to “hold or fold them” – in other words, you can access the funds by way of distribution or vesting (subject to the terms of the trust deed).||Funds are readily accessible from a discretionary trust compared with an SMSF.|
|SMSF||In contrast, with an SMSF, as sole purpose is to fund your retirement, you generally need to wait until you have reached retirement age and retired before you can access your savings.|
|Discretionary trust||Discretionary trust assets do not form part of your estate upon your death.
Any investment property in the trust is normally held for the benefit of all potential beneficiaries. Distributions from the trust can be made to the estate and is subject to tax in the hands of either the executor or beneficiaries.
A new appointer or trustee may need to be appointed if the deceased had either role. Check the trust deed and seek further legal advice if necessary.
|The concessional tax rates available to SMSFs upon the death of an individual makes a SMSF a useful estate planning tool.|
|SMSF||Similarly, an SMSF does not form part of your deceased estate unless the trustee of the SMSF resolves to distribute to the estate.
It is also more difficult for allegedly wronged loved ones to challenge assets held within the SMSF if beneficiaries are paid directly from the SMSF.
Further, there is no tax payable when distributing to a dependent (such as a spouse) whereas there is a 15% tax on the “taxable component” paid to a non-dependant (eg an adult child).
This an extract from Tax & Super Australia’s new publication
SMSF Manual: A Simple Guide to Self Managed Superannuation Funds.
The digital version will be available mid-October,
and the printed version will be available early in the new year
(see more details here).
For other options regarding the ownership of business real property in an SMSF, Tax & Super Australia is hosting a webinar, SMSFs – Real Estate – Purchase & Lease Options, presented by Allen Swan, on October 19. More details here.