How to use a trust to invest in property
So, you’re investing in property in order to sell it at a profit or to earn rental income. Either way this is trade and if the trust owns the property the tax is 45%. How do you avoid this heavy tax?
But firstly, why hold the property in a trust in the first place? The reason is that you want to grow your wealth and you do not want too much wealth when you die as it is subject (after allowances) to 20% Estate Duty and up to 18% CGT, a total 38% of your investment wealth (ignoring the allowances) in taxes on death! If the wealth sits in a trust, then when you die, the trust does not die and no taxes kick in.
That’s the first reason. The second is that if you should be bankrupt, your creditors cannot attack the trust assets, only yours, although if the property is bonded and the trust (or company) that owns the property fails to pay the bond, then clearly the property is at risk.
Now, as time passes, the bond repayments (if the property is bonded) remain the same, but the rental increases each year. Also the deductible interest on the bond reduces, so the taxable income grows for two reasons. (See Property Investors Beware). If the property is owned by a company , which is in turn owned by the trust, then the tax falls from 45% to 28% leaving 72% available to re-invest and build the trust’s property portfolio.
There are those who argue that the rental income can be distributed to various beneficiaries (income splitting) and taxed in their hands, but that sucks money out of the trust and slows the growth in the portfolio. They then argue that the beneficiaries can lend the after tax income back to the trust for further investment, but they forget that the new debt that the trust now owes to those beneficiaries is an asset outside the trust, whereas it should have remained within the trust in the first place.