When you own an investment property -or even you are considering purchasing one- you have likely heard people talk about family trusts. Perhaps this was raised at a dinner party or your accountant dropped the subject. In any case you are now asking yourself: Should I really place my investment home in a family trust?

It is a wonderful question and, truthfully, one cannot give a one-fits-all answer. Family trusts are sometimes an invaluable tool to a particular investor, but they do not match everybody. We shall examine what family trusts are, why people invest in them as investment property, and whether this plan is viable in your case.

What Exactly Is a Family Trust?

Before we start discussing the pros and cons, let’s make sure we are clear about what a family trust actually is.

A family trust is a legal form in which the assets are owned by trustees on behalf of members of the family (also known as beneficiaries). Just imagine that it is a kind of a safe box to your property. It is not that you have no ownership of the assets any longer, but rather the trust does, but you can direct the management of the assets and who gets it.

Various types of trusts exist, although when the majority of the people refer to family trusts in New Zealand, they are in reference to discretionary trusts. These provide leeway to trustees on how income and assets are allocated to the beneficiaries.

Reasons People Put Their Investment Properties in Trusts

The reasons why investors are finding it attractive to transfer their rental properties to a family trust are numerous.

The greatest motivator is likely to be Asset Protection. When you have holdings in a trust you are usually safeguarded against individual creditors. So in case of business failure, or lawsuit, or any other financially ruinous event, the claims are generally exempt against assets in the trust. This insurance can be an asset to those investors who have large property holdings or high risk careers.

Another significant advantage is that of estate planning. This may be facilitated by family trusts that help in making the process of passing wealth to the next generation easier. At death, you do not pass through your estate when the assets are in a trust but rather they are already in the trust structure. This can be an expedited entry to assets of your family, a possible saving to the expense of the management of your estate, and a greater influence over the distribution of your riches.

Lastly, there is the flexibility of income distribution. In the case of a discretionary trust, trustees are given the freedom to determine the distribution of income to the beneficiaries per annum. Nevertheless, some of these advantages have been negated by recent tax regulations in New Zealand especially on the taxation of the income of trustees.

The Cons You Must be Aware Of

Now for the reality check. Family trusts are associated with the real costs and complexities that you should take into account.

Initial and Maintenance Expenses

• Initial and maintenance expenses may be heavy. Creating a trust isn’t free. Legal assistance will be required to have it established, and in case you are dealing with a New Lynn property lawyer or any other property professional, he or she will guide you through the paperwork you need. First-time expenses are normally between a few hundred and thousands of dollars.
• But that’s just the beginning. Trusts need to be maintained: annual accounts, tax returns, meetings of trustees with minutes, frequent reviews. Such continuous professional charges are able to run away into thousands of dollars annually.

Mortgage Complications

Many investors are taken aback by mortgage complications. Banks tend to treat the lending to trusts in a different manner than the lending to individuals. There is a possibility of increased interest rates and increased deposit levels or you may see even more restrictive lending terms. If you already have a mortgage on your investment property, conveying it to a trust means dealing with the trust allocation policies of your bank.

Loss of Bright-Line Test Exemption

The loss of exemption on bright-line test is also present. Under the general rule in New Zealand, the bright-line test is not applicable to your main home. But when you transfer property to a trust you lose the home exemption. This may not be so critical in investment properties but these are to be considered.

Complexity and Responsibility

Complexity and responsibility cannot be underrated. It is not like running a trust, and leaving it alone. The legal liability of trustees is severe. You must maintain good records, conduct yourself in the best interest of beneficiaries, avoid conflicts of interest and remain informed of the dynamic trust laws. Get this wrong and you may end up personally liable or the trust may even be subjected to court scrutiny.

What About Tax Deductions?

One aspect worth considering is how trusts affect your ability to claim deductions on your investment property. While there remain opportunities to claim chattels’ property depreciation and certain improvements on trust-owned property, other layers of trust compliance that are administered seem tougher on tight deadlines. Hence, while a trust cannot prevent you from claiming allowable deductions on property, it does require you to deal with more paperwork for tax purposes.

So, Should You Do It?

Honest opinion here, family trusts are best suited in cases where you have a lot of assets to protect, where there are complex family matters that have to be dealt with, or in cases where there are real fears that you may be liable.

They are likely to be worth taking into consideration in case you are a property investor having multiple rental property, you are running a business with possible legal risk, have an interest in matters of relationship property, or you are seeking advanced estate planning alternatives.

Conversely, it may be excessive in the case that you have just a single investment property, you have a relatively simple financial situation, you are not in a high-income career, and you are discouraged by the continuing expenses and complexity.

Seeking the Advice of a Professional is Essential

Do not rely on this choice just because someone wrote something on a blog. There are complicated legal, tax and financial implications of family trusts, which depend on your own situation.

• Contact an attorney dealing with trusts and property.
• Get an accountant to speak to you about the taxes.
• Discuss with your mortgage broker lending issues.

You can in no way make a wise decision before you have collected all this professional advice.

The Bottom Line

Family trusts can be very useful in the possession of property investors, as these can provide protection of property, estate planning benefits as well as possible tax advantages. However, they are not magic bullets and they have actual costs and liabilities.

The choice must be dependent on your unique financial state, your objectives, risk profile, and professional recommendations in relation to your situation. Trusts are definitely the correct action to some investors. They are a needless complication to others.