There are many advantages when it comes to purchasing investment properties through family discretionary trusts, but one must consider the ins and outs of the land tax threshold and how this would affect them in the long term.
Advisors often recommend property investors to buy property in a family discretionary trust with the main advantages of a discretionary trust being:
- Possible asset protection using a corporate trustee;
- The ability to minimise income tax when distributing profits each year to beneficiaries of the discretionary trust;
- The ability to minimise capital gains tax when distributing any capital gains to beneficiaries to minimise tax on the capital gain made on the sale of the property; and,
- Access to the 50% capital gains tax discount on the sale of the property.
Despite these benefits, which can be material, an issue which is often overlooked is land tax and how the land tax rules apply to discretionary trusts, in particular, the availability of the land tax threshold.
For NSW, the land tax threshold is available to individual property investors, joint owners or tenants in common, companies, fixed unit trusts and self-managed superannuation funds. What this means is that these entities do not pay any land tax until the taxable value of the land they hold exceeds the land tax threshold which is currently $755,000 for NSW. However, a discretionary trust and some unit trusts (i.e. non fixed units trusts) do not receive this threshold and are taxed at a flat rate of 1.6% of the taxable value of the properties.
By way of example, if the taxable value of the interest in a property is $500,000, then a discretionary trust will incur an annual land tax liability of $8,000. However, for an entity entitled to the land tax threshold, where the entity does not own any other interest in NSW property, the entity will be entitled to the land tax threshold, and as the land value is below the land tax threshold, the entity will not have to pay any land tax.
The hidden sting arises where a discretionary trust does not own any NSW land directly but holds units in a property unit trust which owns NSW land and the unit trust is a fixed trust for land tax purposes. In these circumstances NSW land tax applies on a “look through” approach. This means that where a discretionary trust unitholder in a property unit trust holds the units in the property unit trust on trust and the property unit trust owns taxable land in NSW, all discretionary trusts unitholders of the property unit trust will not be entitled to the land tax threshold. Therefore, the discretionary trusts unitholders will be liable for NSW land tax irrespective of their size of their interests in the property unit trust and the value of the land held by the property unit trust.
Essentially the discretionary trust unitholders of the property unit trust will be treated as the owners of the unimproved value of the unit trust property, proportionate to the number of units they each own as a fraction of the total number of units in the unit trust. The discretionary trust unitholders will each be assessed on their share of the unit trust property's taxable value together with any other NSW taxable property they own, subject to a deduction for any land tax paid at ordinary rates by the property unit trust.
In a recent experience involving a matter, a trustee of a discretionary trust had received NSW land tax assessments. The discretionary trust did not own any NSW land directly but held units in several property unit trusts which owned NSW taxable land. The percentage unitholding held by the discretionary trust in the several property units trust varied from as low as 5% to as high as 12%. Revenue NSW issued land tax assessments on the basis that the discretionary trust is to pay land tax with the taxable value being the discretionary trust's share of the unit trust property's taxable value of the land without any land tax threshold being available.
As land tax is incurred and payable every year that the property is owned, the land tax costs can build up over the years. Therefore, it is prudent for property investors to seek professional advice as to the best structure to own property and interests in property and this advice should be sought prior to acquiring the property to make sure the structure is appropriate from the outset. If the property is not initially acquired in the appropriate vehicle, there could be significant costs to change the ownership structure to get it right.
Note that land tax laws vary state by state within Australia.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.