Trusts and property investments – What you should know
In New Zealand, commonly used legal structures for holding investment properties include personal name, trusts, and look-through companies. Each have their own benefits and drawbacks, and their usage will vary depending on the user’s circumstances. This article provides background information on the Look-through Company, and the benefits and drawbacks associated with using this legal structure for property investment in New Zealand.
A trust is a legal entity that can hold and protect assets placed into the trust against unwanted claims. The protection that a trust can offer comes from the fact that once an asset has been placed into a trust, it is effectively owned by the trust rather than by asset’s owner.
A trust is formed when a person (“settlor”) places assets under the control of a person (“trustee”) for the benefit of some other person(s) (“beneficiaries”) or some other purpose. The exact details of a trust can vary, but will always be documented in a document called the trust deed.
- Asset protection. Since you no longer “own” the properties you placed under into the trust’s care, the trust may be able to protect those properties from unwanted claims, e.g. claims from former partners. The properties may also be protected from creditors to whom you have given personal guarantees, since you do not personally own the properties.
- Wealth preservation. Placing properties into a family trust allows for wealth to be preserved for your family, as the trustees will in theory act in the best interest of the beneficiaries, i.e. you and your family. This should in theory result in the preservation of asset value for your family in case of your death.
- Better financial planning. As the properties are no longer under your control, you may be potentially forced to be more prudent in your financial planning.
- Better asset management. It may be potentially easier to manage your properties once their ownership have been consolidated in a trust.
- Improved confidentiality. Once your properties have been placed in a trust, it will be very difficult for others to use ownership records to determine who owns the properties.
- Limited distribution. A trust can only distribute profits, not losses, to its beneficiaries. From an investment point of view, not being able to use rental losses from your properties to offset against your taxable income can be a major drawback.
- Increased costs. Typically a trust would have at least one, if not more, independent trustee in order to avoid suggestions of the settlor maintaining control over properties gifted/sold to the trust, which would result in the trust be deemed a “sham” trust and invalidated by the Inland Revenue Department (IRD). By employing an independent trustee(s), the cost of using a trust to own investment properties may increase significantly compared to owning the properties under your own name.
- Potential loss of control. As management decisions must be made by agreement from all trustees, this may potentially result in less control over your investment properties if there are independent trustees involved.
- Higher marginal tax rate. Trusts are taxed at 33% versus 28% under a company structure such as a LTC.
Taking all of the above into consideration, a property investor should ideally use the trust to own their family home due to its asset protection qualities, and adopt an alternative form of ownership structure such as personal ownership or a company when it comes to rental properties.
The information provided in this article is not intended to provide a comprehensive statement of relevant laws and should not be used as a substitute for legal advice. Please consult an expert for advice tailored specifically to your own circumstances.
Published on Tuesday, August 5th, 2014, under Buying Property