s Special Report

Property Investment Structures

InvestorOne Pty Limited

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SYDNEY NSW 2000
info@investorone.com.au
www.investorone.com.au
Contents

Introduction 3
Problem with residential investment property 4
The way to avoid the problem 5
Hybrid discretionary trust/unit trust combo 6
Roy Morgan research 7
Who is the property owned by? 8
Did you get professional advice? 9
Were you aware of unit trust and superannuation? 10
Was the property to form part of your retirement? 11
Form of ownership and who advised 12
Ownership by age 13
Comparisons 14
Unit trusts 15
Borrowing with a unit trust (negative gearing) 16
Unit trust/hybrid discretionary trust combo 17
Unit trust/hybrid discretionary trust/superfund combo 18
Other material 19

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Introduction

This report looks at two alternative methods for the holding of residential rental
properties, which both provide the greatest amount of flexibility and tax -efficiency
and should be considered by every person looking to invest in property. For
years, many people have promoted the benefits of residential property investment.
Some will tell you it’s been the best investment of their lives , while others who
went to less scrupulous promoters, overpaid for their investment and, in some
cases, lost their homes. Generally, however, residential investment properties will
remain a staple diet for those people who want to build their wealth.

When considering the acquisition of any asset, it’s crucial to consider how the
asset is going to be held. That is to say, do you acquire it in your own name , in a
company, in a trust, or in a superannuation fu nd? The Government has decided to
partially reinstate the ability to combine superannuation, residential property and
debt. Yes, you can now use the funds in your self-managed superfund as a
deposit on a residential investment property. Up until 11 Augu st 1999, many
people had used their super as a deposit on property in an arrangement that used
a unit trust. This was, however, outlawed, and effectively spelt the end of private
superannuation funds investing in residential real estate.

Although a new dawn is about to start with self-managed superfunds borrowing,

this will not apply to every person. For a whole range of reasons , people may still
elect to acquire assets, including residential rental properties , outside of the
superannuation environment. As will become apparent, many people (both prior
to 1999 and after) have acquired residential rental property in a way that limits
their options in the future.

This paper is not about self-managed superannuation funds borrowing to acquire

residential properties - that paper will be available early in 2008.

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Problem with residential investment property

Since 11 August 1999, when a change in the relevant law occurred, there has
been something different about residential property and other types of assets that
can be superannuation investments that have gone largely unnoticed. Unlike
listed shares, managed funds, listed property trusts, commercial property and
industrial property, residential property is prohibited from being transferred to a
person’s superannuation fund, if it’s owned by the person or a related party. The
legislation provides that if anyone breache s this prohibition, then the penalty is 12
months imprisonment.

What this means is that if a husband and wife , or either one of them, owns a
residential property in their own name(s) , then they’re prohibited from
transferring that property to their self -managed superfund for their retirement.
This is also the case if the residential property is owned by their company or
family trust. Since the introduction of the favorable concessions applying to
superannuation from July 2007 in what’s become known as Better Super, it’s
become very important to look at how your retirement assets are structured. This
is especially the case with residential investment property.

There are sound reasons for transferring assets to a self-managed superannuation

fund. In the past, many people have done so as a form of superannuation
contribution, in order to shelter their investment assets in a tax-friendly
environment with additional asset protection. Others have sold their assets to
their superannuation fund prior to their retirement, as a way of accessing their
super. Of course, post August 1999, these activities have been restricted to listed
securities and commercial and industrial property.

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The way to avoid the problem

The only way you can acquire a residential property outside of a superannuation
fund and later have its rents and any capital gains subject to taxation in a
superannuation fund, is to originally acquire the property in a unit trust. A unit
trust is a trust, the beneficiaries of which are known as unitholders. This is
because they hold units, which describe their rights to the income and capital of
the trust. The most common type of unit trust would have either a company or
mum and dad as its trustee, with mum and dad holding ordinary units which
entitle them to equal shares of the income and capital. More information about
unit trusts is available at the end of this paper.

If the unitholders in the unit trust approach a bank to borrow funds to buy their
units, and the property is acquired in the trust, then the tax and economic effects
of this arrangement are basically the same as if the unitholders owned the
property in their own name. The main difference is that the unitholders can either
redeem their units in the unit trust with a corresponding issue to a self -managed
superfund, or they can just sell their units to the superfund. There may be
income tax and/or stamp duty consequences for this transaction, and advice
should be sought before any action is undertaken. Holding a property in a unit
trust may also have land tax ramifications , with the laws in each state and
territory being different.

It is therefore important when considering any investment property purchase to

consider using a unit trust.

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Hybrid Discretionary Trust and Unit Trust combo

An arrangement where a property is acquired in a unit trust, and all the units in
that unit trust are issued to a hybrid discretionary trust, offers the greatest in
terms of asset protection, options, flexibility and tax-efficiency. Hybrid
discretionary trusts have many unique features and can cost more in both
administration and accounting fees, as well as incur greater liabilities to some
state/territory and federal taxes. Nevertheless, they should be considered by
every investor in property, whether it’s residential, commercial or industrial.

The hybrid discretionary trust and unit trust combo allow s for negative-gearing by
the high income-earner in a family for a number of years. The units in the hybrid
discretionary trust that are owned by that person may be subsequently redeemed,
and then the income of the trust, including any realised capital gains, is able to be
distributed by the trustee on a discretionary basis . Of course, the refinancing
principle applies to the units issued by the hybrid discretionary trust. As the
property is acquired in a unit trust , a self-managed superfund could acquire unit s
at a later stage, subject to the satisfaction of certain conditions.

If the borrowing to acquire the units in the hybrid discretionary trust was secured
over assets other than the property in the unit trust , then, provided that the unit
trust has no borrowings, the superfund can acquire units in it. If the high income-
earner enters into a salary sacrifice arrangement so that some of their pre -tax pay
is contributed to their self-managed superannuation fund, then those funds can be
directed through the unit trust to the hybrid discretionary trust , and used to
redeem their units in the hybrid discretionary trust and pay down debt.

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Roy Morgan research

In a recent survey undertaken by Roy Morgan on behalf of InvestorOne Pty

Limited, only 1% of residential property investors surveyed held the property in a
unit trust. The results are surprising, considering the prohibition on a person
transferring their residential rental property to their super , unless its owned by a
unit trust. In addition, 78% of residential property investors surveyed stated that
they purchased the property as part of their retirement planning, and yet acquired
it in such a way that they can never transfer it to their superfund.

The research gives a real insight into the psyche of the residential property
investor and what motivates them to acquire a property. The survey also included
questions concerning where investors got advice, whether they knew of the
restrictions when a unit trust isn’t used, and whether they’d use a trust for their
next purchase. Again, the results were
surprising and reinforce the argument
that investors are not getting the right
advice or information concerning property
Only 1% of residential
investment. investment property
owners selected the most
There has been a steady shift in the
methods by which property is held from flexible and tax efficient
the traditional structure of the own name
structure.
of an individual to discretionary trusts.
However, the idea of using a unit trust to
involve a superfund has not really
filtered-through since the introduction of legislati ve changes in 1999. From this,
it’s obvious that investors and their advisors aren ’t well informed when it comes to
structuring residential property investments.

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Who is the property owned by?

Roy Morgan Research started the mentioned survey by asking who owns the
property. This time, the results were startling - over 90% of all purchases were
made in individuals’ names. Approximately 5% were held in discretionary and
family trusts and 2% were held in companies. Therefore , in excess of 98% of all
investors cannot transfer their property to their self-managed superfund!!

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Did you get professional advice?

The respondents to the mentioned survey were asked where (if at all) they got
their advice. The majority said that they sought advice from either an accountant,
financial planner, solicitor or other professional. This is actually a poor indictment
on the various professions, because it means that they’re either not advising their
clients or the clients aren’t listening to the ir advice. It would appear that the
majority of investors aren’t being advised of all the options available to them.

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Were you aware of unit trust and superannuation?

Over 63% of those who were surveyed weren’t aware of the ability to move a
residential investment property to a superannuation environment, if the property
had originally been acquired in a unit trust. Unfortunately, the majority of the
investors who sought advice from a professional just weren’t advised of the
options available to them. Obviously, the majority of those people that didn’t get
advice from anyone also acquired the property in their own name.

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Was the property to form part of your retirement?

More than 78% of all people interviewed indicated that the residential investment
property they’d acquired was to form part of their retirement assets. When you
consider the tax-free status of superannuation in certain cases and the ability to
enter salary sacrifice arrangements and pay-down debts very tax-efficiently, its
deeply concerning that that less than 1% of people acquired residential
investment properties in a unit trust, particularly when you have regard to the
long-term motives they had in doing so.

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Form of ownership and who advised

It’s fascinating to see the break-up of investment structures, based on who

provided the advice. The results show that accountants tend to favour family and
discretionary trusts as well as companies. No body that acquired their residential
investment property in a self-managed superfund was advised to do so by an
accountant or a financial planner, and nobody acquiring the property in a unit
trust received advice to do so from a solicitor.

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Ownership by age

Not surprisingly, the only people acquiring a residential investment property in a

unit trust were in the over 50’s age group. Those in the 35-49 age group
predominantly selected the use of a discretionary or family trust. The curious
result here was that over 50% of those aged between 14 and 34 acquired their
property in a company.

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Comparisons
The structures below WOULD
NOT allow for the investment
property to be transferred to a
self-managed superfund.
The structures below WOULD
allow for the investment property
to be transferred to a self-
managed superfund.

Smith Unit Trust

Trustee

Own name - individual Individual as unitholder

Smith Unit Trust

Trustee

Own name - couple Couple as unitholders

Smith Family Trust Smith Unit Trust

Trustee Trustee

Discretionary
Trust Smith
Discretionary Trust Trustee

Smith Pty Limited

Smith Unit Trust

Trustee

Company
Smith Hybrid
Discretionary Trust Trustee

BANK

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Unit trusts

Trustee
The trustee can be mum or dad or mum
and dad. Many people use a company
which is an overkill if the trust is to hold
a passive asset like real estate.
NOTE. The trustee and unitholders
should not be identical.

Trust Deed
The trust deed governs
the terms of the trust Unit Trust Trustee
and the powers and
responsibilities of the
trustee and rights of
unitholders.

Mr A – an ordinary Mrs A – an ordinary

unitholder (entitled to a unitholder (entitled to a
proportion of the proportion of the
income and capital of income and capital of
the trust). the trust).

Unitholders
The unitholders are entitled to a fixed
share of income and capital equal to
their proportion of the units held.

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Borrowing with a unit trust (negative gearing)

Unit Trust
Trustee

Money borrowed by Mr A would be

deductible to him, if it was used to purchase
ordinary units giving him rights to receive
income and realised capital gains.

Mr A – an ordinary unitholder
(entitled to a proportion of the BANK Mrs A – an ordinary unitholder
income and capital of the (entitled to a proportion of the
trust). income and capital of the trust).

Borrowing
Any borrowing to fund the purchase of
an asset in a unit trust should be
undertaken by the unitholder. In this
case dad borrows to acquire his units to
get the benefits of negative gearing.

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 Unit trust/hybrid discretionary trust combo

Unit Trust
Trustee

Ordinary
Unitholder

Hybrid Discretionary Trustee

Trust

Discretionary
Beneficiaries

Money borrowed by Mr A would be

deductible to him, if it was used to purchase
ordinary units giving him rights to receive
income and realised capital gains.

BANK
Mr A – an income unitholder
(entitled to a proportion of the
income only of the trust, which
would include realised capital
gains).
Unit/hybrid combo
The unit trust/hybrid discretionary
trust combination does provide the
most flexibility and tax efficiency.
The costs and complexity are
negatives to the structure and
advice should be sought before
entering this type of arrangement.

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 Unit trust/hybrid discretionary trust/superfund combo

Unit Trust
Trustee

Ordinary Ordinary
Unitholder Unitholder
Trustee(entitled income (entitled income
Trustees
and Family
Hybrid and
Superannuation
capital)Trust capital)
Fund

Discretionary
Money borrowed by Mr A
Beneficiaries
would be deductible to him, if
it was used to purchase
ordinary units giving him rights
to receive income and realised Superfund Members
capital gains.

Mr A – an income unitholder
(entitled to a proportion of
the income only of the trust,
which would include realised
capital gains).
BANK Unit/hybrid/superfund combo
Where the property acquired in
the unit trust won’t be used as
security the superfund can be
involved from the beginning either
providing a deposit or a salary
sacrifice tax strategy.

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Other material

The following material will be available o n www.investorone.com.au from 10

December 2007.

PDF Documents

Special report – Double taxation and unit trusts (Members only)

How to guide – How to set up a unit trust

How to guide – How to set up a superfund
How to guide – How to negative gear with a trust
How to guide – How to avoid poisoning property
How to guide – Tips and traps with unit trusts
How to guide – Moving residential property to super – the solution (members only)

Online videos

What is a trust?
Negative gearing with a trust
Why should I use a trust?
Hybrid discretionary trusts
Tips and traps with unit trusts
Residential investment property – the solution (members only)

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