To trust or not to trust – the benefits of a discretionary (family) trust for minimising income tax

A few weeks ago I blogged about the insignificant benefits of a discretionary (or family) trust compared with a basic 50-50 joint split when it came to Capital Gains Tax (CGT), this week I will compare the two when it comes to rental income.

Rental income is different to CGT in that rental income is generally a lot less, and secondly, it is an annual income so any tax benefits can be compounded yearly. The results should be the same for values when Capital Gain and Rental Income are he same.

Again, I have based the below charts on a 50-50 split were one person has an supplementary income of $100,000 per year. I have ranged the annual rental income from minus $250,000 to plus $250,000, this is a huge sum for rental income and would require around $5000 rental income per week, and this is all after management costs and deductions.

A basic comparison between the two, with annual rental income versus total tax payable, it can be observed that that at values less than -$163,500 (a significant yearly loss), the 50-50 split can use negative gearing to offset the individual $100,000 supplementary income, whilst the discretionary trust cannot take advantage of negative gearing. This means there will always be a $25,000 tax bill as long as the properties are negatively geared.  As the net rental income approaches zero (or neutrally geared), the 50-50 split tax and trust tax merge.

50-50 split tax versus family trust tax

Finally, once the property is positively geared, the benefits of a discretionary trust are visible; the first $18,200 is tax free and following from there the tax bill is always slightly lower than the 50-50 split.

Plotting the tax difference between the two, a positive value being when a discretionary trust is beneficial, it can be observed that the maximum difference is around $3,300 with incomes around $18,000 to $36,000, this is a significant yearly saving.

The tax difference between a 50-50 split and family trust

Looking at the percentage difference compared to the yearly income, it can be again observed that at $18,000 or income a maximum of around 18% can be saved when a discretionary trust is used. It dips and stops at around a yearly income of$70,000 were it then hovers around 1% percentage difference.

The tax percent difference between a 50-50 split and family trust

So what does this all mean?

Firstly, a discretionary trust should not be used for negatively geared properties, this is obvious.

Secondly, a discretionary trust has significant benefits when used for positively geared properties. And because this in annual income, these benefits are compounded yearly. A saving of $3,300 yearly is a saving of $33,000 over ten years.

So one would think it would be wise to move the properties into a discretionary trust as soon as the properties are positively geared.

I will investigate this in my next post.

Update September 2012

Something I failed to mention was that whilst a trust is not beneficial for negative gearing, losses stay in the trust, meaning when the income is positively geared, tax will be minimised while the losses are accounted for.

Correspondence with Property Manager LJ Hooker Belmont WA – Tenant in Rent Arrears

On 1st October LJ Hooker Belmont WA informs we that the tenant had not paid rent for 2 weeks,

“the tenant has only paid to the 16/09 and has been breached and I spoke to him and he is coming in on Tuesday and Wednesday to pay the backlog.”

I asked about when a Breach Notice for Non-Payment of Rent was issued and LJ Hooker Belmont WA seemed to suggest that it has just been that day (possibly after I asked about it). There is an additional 17 days that must be waited prior to termination (two weeks plus few days for breach delivery in the mail), this meant that the breach expired on the 17th October, the two week delay in issuing the breach by LJ Hooker Belmont WA meant that I had to wait 1 month before even issuing a Termination for Non-Payment of Rent, and if the tenant refuses to leave, a court case can take another 10 to 14 days (quoted from LJ Hooker Belmont WA). Now don’t forget the bond only covers 4 weeks of rent.

On Saturday 1st October, LJ Hooker Belmont WA informs me;

“I spoke to him and he is coming in on Tuesday and Wednesday [4th and 5th October] to pay the backlog [$680]”

On Thursday 6th October I receive an email;

“Your tenant has paid rent $550 today… and is now $310 in arrears.”

On Friday 7th October I receive another email;

“He has assured me he will pay $400 on Wednesday [12th October] and $400 each week until he has caught up again.”

On Friday 14th October I receive another email;

“The tenant paid $250 today and paying $740 on Wednesday and this will take him upto [sic] the 21 October. “

On 18th October Termination for Non-Payment of Rent is issued by LJ Hooker Belmont WA, the tenant has till the 27th October to vacate.

On 27th October LJ Hooker Belmont WA informs me that Jacaranda Community Centre has approved payment of the tenant’s rent arrears.

On the 4th November LJ Hooker Belmont WA that the tenant has paid all rent arrears and is up to date with payments.

Now this was one of the added advantages of having a Property Manager, they know who to contact, Jacaranda Community Centre is a community service centre for the City of Belmont who assist with people in financial hardship, and in this case they paid all rent arrears and brought the tenant up to date with payments.

I also decided to take up Landlord Insurance, which LJ Hooker Belmont WA advised from the very start to do, I went with AMA Insurance, for about $150 a year you are covered for about $17,000 of lost rent, not bad at all.

Correspondence with Property Manager LJ Hooker Belmont WA – First Tenants

On 12 July property manager LJ Hooker Belmont WA sends me a tenant application, the first I have received;

I have an application to the above property.  Single dad with a 9 year old son. 

Great! I thought, finally back making some rent. A Residential Enquiry Database Report from TICA was also included in the email.

A follow-up email by LJ Hooker Belmont WA was a request from the prospective tenants if they could make some modifications to the property;

The tenant requested if he and his son can put a vegie [sic] garden and fix the chicken pen up.  He has to [sic] small dogs (Chihuahua) and would like chickens.  I didn’t think that would be a problem.

Not a problem at all, I replied, happy to oblige.

By 23 July the tenant had moved in.