Property problems: Avoid using trust for investment properties

Q: I have recently inherited $400,000 and, at age 40, I want to ensure these funds are invested for my retirement.

I am now single but have children to provide for in the years ahead.

I have always wanted to build my own portfolio of investment properties. My intention is to purchase four to six properties using a portion of the cash inheritance as a deposit on each and borrowing the balance.

I have an existing home which is owned by my family trust and has a $300,000 mortgage on it.

Should I buy the investment properties personally or in the name of my trust?

A: In your circumstances, the preferred approach would be to avoid using the family trust to purchase these properties. The family trust is first and foremost designed to protect the family home and other family assets from business failure and personal creditors.

When making a decision about the best legal structure for property investment you should look for the one that maximises the benefits to you in your current personal circumstances.

First, the structure should provide protection for your family home. You won't want the family home exposed to creditors should the investment falter.

Second, the structure should be tax effective and if possible reduce your own personal tax liability as much as possible.

Third, you will want a structure that gives you enough flexibility to meet any change in circumstances. For example, a company enables you to bring in future investors through the issue of shares.

One way to achieve the above aims is to use a combination of a trust and a "qualifying" company to own the family home and the investment properties respectively. There are of course other options, all of which should be evaluated by, and discussed with, your professional advisers before proceeding.

You can continue with the status quo in relation to the family home and leave that in the ownership of the existing family trust. This will ensure the family home continues to be protected from personal creditors.

You could use your inheritance money to clear the $300,000 bank mortgage on your family home. This can be done by lending the $300,000 to the trust in return for an acknowledgment of debt or a mortgage back to secure the loan. This loan would be gifted to the trust on an annual basis until extinguished.

If you decide that the above approach suits your needs, the next step would be to have your lawyer set up a company with you as sole director and shareholder. The company (and you as a shareholder) must apply to the IRD and elect to become a loss attributing qualifying company ("LAQC").

Electing to have LAQC status for the company will enable you to reduce your own personal tax liability. This is because the law allows you as a shareholder to use the tax losses incurred by the company to reduce your own personal taxable income.

Losses may arise if there is "negative gearing" (i.e. the interest on borrowing to purchase the investment properties costs more than rents received).

Hopefully, rental returns from these properties will meet a substantial amount of the outgoings. When the loans are repaid and the properties are mortgage free you can consider if some, or all, of your shares in the company should be transferred to your trust so that the equity is protected from personal creditors.

When approaching a lender, it is sensible to ensure that wherever possible the trust is not required to guarantee the loan obligations of your company. You should endeavour to keep your investment properties in a separate stand-alone structure.

It would be wise to involve your trust lawyers and your tax professional at all stages when you are setting up the above structure.