For the 2018 to 2019 tax year the tax free threshold for resident taxpayer individuals is $18,200 per year in taxable income. That means earning under this amount results in no income tax payable.
However, a taxpayer could earn slightly more than this and pay no tax because of 2 rebates that are available:
This means that an individual resident individual could actually earn $21,885 per year and not have to pay tax.
However, if the individual is eligible for the Seniors and Pensioners Tax Offset (SAPTO) they could potentially earn up to $33,000 per year and not have to pay tax.
We have seen that it can be possible for a discretionary trust to distribute income to a SMSF if the SMSF is a beneficiary of the trust. See my legal tip
But just because it can be done doesn’t mean it should be done.
Any distribution from a related discretionary trust received by a SMSF will be classed as NALI or ‘Non Arms Length Income’.
NALI income will be taxed in a SMSF at the highest marginal tax rate.
Income from Fixed Trusts to a SMSF can be taxed at normal SMSF rates, 15% generally, but only where the income is genuine non-NALI income. For example a SMSF owning units in a Fixed Unit Trust which owns a factory. Genuine rent can flow through to the SMSF and be taxed at 15%. But if a discretionary trust distributes income to the unit trust this would flow through to the SMSF but be taxed at the top marginal tax rate.
The reasons for these laws are to stop people diverting income to SMSFs to save tax.
Discuss this at https://www.propertychat.com.au/community/threads/tax-tip-196-discretionary-trusts-distributing-income-to-a-smsf.38915/
A SMSF is a trust and a discretionary trust could potentially distribute to another trust. But, the Trustee of a Discretionary Trust can only distribute income to beneficiaries of that trust if the SMSF meets the definition of beneficiary as defined in the deed. If the SMSF is a beneficiary of the discretionary trust then it would be possible for it to receive income and/or capital from the discretionary trust.
BUT (and there is always a but) – just because it could be done doesn’t mean it should be done. See my tax tip for some of the tax consequences.
Discuss this topic at https://www.propertychat.com.au/community/threads/legal-tip-198-legal-tip-can-a-discretionary-trust-distribute-income-to-a-smsf.38916/
There is no time limit as to how long you can carry forward losses – whether income losses or capital losses, however they will be lost at death (a loss lost!). So, it makes sense that you should try to use up losses as early as possible. This is generally not too hard with income losses as these are easily eaten up the next financial year with more income being earned.
Using up capital losses tends to be more difficult though as a capital loss can only be used up by a capital gain – not general income.
Note that there are complex rules regarding companies and trusts in carrying forward losses.
Homer invested money in a business he ran which failed. He lost $200,000 and has a $200,000 capital loss which he has been carrying forward for 9 years now. Homer would love to use this loss up, but the trouble is he has no other asset he could sell to offset the loss.
If Homer owned shares for example he could sell shares with a $200,000 capital gain and not have to pay any tax.
But losing his money has meant that Homer doesn’t have any capital to invest with.
However, Homer’s daughter Lisa knows a thing or 2 so sets up a discretionary trust to hold investments. It could be possible that in future a gain from the trust could be distributed to Homer and his loss could offset this so that no tax is payable.
Discuss this topic here
I have outlined what a declaration of trust is here http://www.structuring.com.au/terry/trusts/declaration-of-trust/ .
What are the CGT consequences of a person declaring that they now hold an asset as trustee? There is no change in title, so most people probably think there are no tax consequences, but there are.
CGT Event E1 (section 104-55(1) ITAA97) happens when someone declares a trust over existing property they own. This is because there is a change of beneficial ownership, even though the legal ownership remains the same.
Homer holds 100 shares in CBA. He makes a declaration of trust that he now holds these shares on trust under the terms of the Simpson Family Trust deed. No change of ownership has happened, but this has triggered CGT just as if there was a sale of those shares to a 3rd party. If the cost base of the shares was $100,000 and the market value is now $200,000 that would mean a $100,000 capital gain is made (which may then get the 50% CGT discount etc).
(Homer should have sought legal advice as there are ‘better’ ways of doing this)
Where a trust has income and no one is presently entitled to it, the trustee of the trust will be taxed on this income at the top marginal tax rate because of s99A(4) ITAA36
Note that the income doesn’t necessarily need to be distributed, it could be retained by the trust yet still be taxed in the hands of the beneficiary if they have been made presently entitled to it.
On present entitlements and trusts see this post I wrote a few years ago:
Legal Tip 87: Trusts and Unpaid Present Entitlements
Simpson family trust has $10,000 in income in year 1. The trustee makes Bart presently entitled to the income so Bart is the one that is taxed on this income. The trustee may not physical transfer the money, but if the is the case Bart will still be taxed (and he will have an unpaid present entitlement with the trust, which is similar to a loan). Bart has no other income and pays no tax.
In year 2 the trust has $10,000 in income, but the trustee doesn’t make anyone presently entitled – perhaps they forgot, or perhaps their resolutions were defective.
The trustee will pay the tax at the top tax 47%
If you moved to a cheaper area to live and took a haircut on your wage, it might not be as bad as you think. This is can speed up financial independence and reduce stress and give you a better quality life.
Example of a $20,000 wage reduction
After tax income on $100,000 would be $73,883 (2018-19 tax year)
After tax income on $80,000 would be $61,383
So, a $20,000 reduction in gross income means only a $12,500 reduction in real terms
Try working it out yourself at https://www.taxcalc.com.au/
But the real benefit may be the savings with home ownership.
An equivalent house costing say $1mil in Sydney v $600,000 in Adelaide (for example)
Repayments on $1mil at 4% pa are
Repayments on $600k at 4% pa are
The repayments on the smaller loan mean a cash flow saving of $22,920 per year – which more than makes up for the lower wage income.
Furthermore, if you consider commuting times – you might be saving 1 or 2 hours per day living outside of Sydney.
Living costs may also be generally cheaper. Consumer prices are supposedly about 12.75% higher in Sydney than Adelaide:
Consider also the quality of life.
It can be worth moving out of Sydney and living elsewhere and this can be the case even if you were to take a substantial haircut on your income.
What is the point, you might ask, in setting up a discretionary trust to hold investment assets when you have no family?
A discretionary trust needs at least one beneficiary with the trustee having the option to retain income, or at least 2 beneficiaries where it doesn’t. However, most discretionary trusts will have hundreds of potential beneficiaries as they will be set up with one or two named persons as the primary beneficiary and then there will be secondary and, possibly, tertiary beneficiaries who are relations of the primary beneficiary.
So even though you are on your own now, you might have cousins or distant relatives who could be beneficiaries – this doesn’t mean they need to be recipients of trust income, but just that they could be. You never know when one of your cousins might invest in shares and lose the money and have carried forward income or capital losses.
There is also the issue that even though you may not have any family now, you may get a spouse at a future date. There may even be children and then grandchildren. All these people could and probably would be beneficiaries of the trust. This is generally the case even if they do not ‘exist’ at the time the trust was created.
Perhaps most importantly, a company could also be a beneficiary of the trust. This may allow for use of the bucket company strategy of diverting income to the company to cap the tax rate at 30%. Later on, the retained earnings in the company could be distributed to future family members (providing the shares of the bucket company are held by a different trust).
There are also the asset protection aspects to consider. Not having a spouse may mean holding all assets yourself and taking a risk of not ending up bankrupt. Where the assets are held on trust, the assets are generally much safer from attack should the controller of the trust become bankrupt at some point.
There are 2 major issues when taxpayers want to claim the interest on a loan relating to a former main residence:
Redrawn amounts and Mixed Loans
Interest is only deductible if the loan it is incurred on was used to purchase the property, or for improvements etc. Where any amounts have ever been redrawn from a loan the interest would need to be apportioned.
Tyrell borrowed $500,000 to buy a main residence. Along the way she paid it down to $450,000 and then redrew $50,000 to buy a yacht (which is actually a small boat, but sounds better if he calls it a yatch).
This loan no longer relates solely to the property but is a mixed purpose loan so only 450/500 or 90% of any interest on the loan could be deductible once the property is available for rent.
David used a LOC for his loan to purchase his main residence and borrowed $500,000 initially. Every week he deposited his salary and then redrew amounts to live on. The amount of the loan relating to the property will decrease each week and at the end of 5 years the loan would be extremely mixed.
He would have to spend hours to work out the portion of the loan relating to the property and might find that this might only be 10% of the loan amount.
(this is why you should never use a LOC as the main loan, but only to ‘access’ equity)
The other issue is timing. A person cannot start claiming interest until the property is available for rent. This is generally only after you have moved out and have advertised the property for rent at market rates. While you are living in the property and advertising it the property wouldn’t be available for rent, so you could not claim interest during this period.
There are also timing issues on when interest is incurred and debited to an account because interest is generally incurred daily but added monthly to the loan.
Example 3Let’s say someone moves out on the 30th and immediately advertises the property for rent and on 1st of the following month they are charged $1,000 in interest. Can they claim that interest? No, well not in full because interest is charged in arrears and added to the account monthly. So, 29 days of that interest related to the period you would living in the property. So, in the first month only 1/30th of that $1,000 should be claimed.
Some people have carried forward capital losses. These losses can usually be carried forward until the taxpayer has a capital gain which can ‘soak up’ the capital loss.
I think it is a good idea to use up these losses as soon as possible.
The main reason being that losses are ‘lost’ at death. If the taxpayer dies their loss cannot be passed on to any other person who could utilise it. Don’t lose a loss!
Bart bought a property in a mining town for $1,200,000. He ended up selling it for $700,000 and has a carried forward capital loss of $500,000.
Bart dies and leaves a rental property that he owns to his sister Lisa. The property has a $500,000 capital gain.
Unfortunately, Bart’s loss will not benefit anyone. Lisa will inherit the investment property pregnant with a $500,000 gain, yet she cannot benefit from the loss.
Had Bart sold the investment property before his death he might have made $500,000 tax free and this money could have been passed onto Lisa. He might have even sold the property to Lisa – perhaps with vendor finance if she couldn’t have afforded a loan. Also, if Bart had a flexible will his estate could have sold the property and possibly used up the gain.
Another reason to use up capital losses is their benefits with debt recycling. Making capital gains without needing to pay tax will mean there is more money with which the non-deductible debt can be reduced.
Example of Debt Recycling
Lisa has a $100,000 capital loss from some bad share investments many years ago. Because of this she has a large amount of debt still outstanding on her main residence. But this has not stopped her investing in shares again. She has learnt from her mistakes and is now making some good capital gains.
If Lisa’s shares increased in value by, say $20,000 in the first year, she could sell these shares, pay no tax, and use the proceeds to pay down the non-deductible debt, and then invest in more shares and repeat.
Doing this has 2 advantages
Speak to your tax lawyer or tax agent.
If someone sells a property and has a large capital gain is it worthwhile taking a whole year off work to save tax? In my view it is always great to take a year off work, but it might not actually save you that much tax.
Richie Rich is about to sell an investment property with a $200,000 capital gain. He is sick of it under performing and draining him with land taxand has a low yield. Richie is toying with the idea of taking a whole year off work to save CGT. Is it worth it?
Let’s assume Richie earns $100,000 in his job, and the sale will happen in the 2018-2019 financial year.
If he sells the $200,000 gain will be reduced to $100,000(due to holding it longer than 12 months) and added to his other income for the tax year. The result is an annual income of $200,000
Tax on $100,000 $26,117 Net income $73,883
Tax on $200,000 $67,097 Net income $132,903
Difference $40,980 Difference $59,020
The Capital Gain will mean $40,980 in extra tax payable for the year.
This means by giving up a year’s income from work Richie would only earn $100,000 from the capital gain. Therefore, he will save $40,980 in tax by not working.
But not working means he has less income, working the full year in which the sale occurs will net him only $59,020 as opposed to his normal $73,883 (a difference of $14,863).
He would need to determine if the effort of working is worth the pay cut of $14,863 which is about $286 per week.
He should also factor in transport costs to work and other work-related costs – clothing, lunches etc. and there are also heaps of non-financial things to consider. There would be time to do other things such as:
Written by Terry Waugh of www.structuringlawyers.com.au
It is best not to use cash as deposit for an investment property, especially if you will have a main residence loan. Using cash on an investment reduces your deductions and increases your non-deductible interest.
But what do you do if you don’t have a main residence at the moment, but at looking to acquire one soon?
It is possible to use cash as security for a loan. Normally you may not want to or need to do this, but it is possible, and it can assist with maintaining high interest deductions in some situations.
Generally, the security used for a loan does not affect the deductibility of interest. This means anything can be used as security for a loan without effecting the deductibility of interest. The security could be shares, cash or even a car.
The beauty of cash is that it doesn’t need to be valued or sold for the lender to recover its money so the potential LVR on a loan secured by cash is 100%.
Tom has $100,000 cash and wants to buy an investment property for $500,000 before he buys his Main Residence. He might be doing this because he has found a ‘bargain’.
Normally Tom would pay a $100,000 deposit and then borrow $400,000 for the $500,000 property. But doing this would mean that going forward Tom would have $100,000 less for the future main residence. He may be able to access it and borrow against the investment property, but this will have some bad tax consequences:
$100,000 x 5% = $5,000 less per year in tax deductions for the next x years (life of the loan).
So instead using the cash as a deposit Tom could use the $100,000 cash as security and borrow $500,000. Ideally this would be done in the form of 2 loans
Loan A $400,000 secured by a $500,000 property. LVR 80%
Loan B $100,000 secured by a $100,000 term deposit. LVR 100%.
Tom could wait for capital growth (from natural market increase and/or a quick reno) and then release the cash, or if Tom quickly buys the new main residence the cash could be released, and the main residence used as security for the investment loan.
This could happen like this:
Loan A $400,000 secured by the IP. interest deductible against the IP
Loan B $100,000 now secured by the main residence. Interest is deductible against theIP
Loan C $400,000 secured by the main residence. Interest not deductible. The $100,000 term deposit is released and used at settlement to pay for $100,000 of the purchase price of the main residence.
Overall 90% LVR.
As above. $500,000 property with a $500,000 loan secured by both the property and the cash.
After 2 years the property is now worth $625,000. Tom applies to remove the cash as security and the bank agrees as the LVR is now 80% based on the property value alone.
$100,000 cash is then used as deposit for the main residence. Tom has an extra $5,000 per year in tax deductions for the next 30 years plus.
Tom has 2 properties securing 2 loans at ABC Bank.
Tom sells his main residence and will buy a replacement main residence in a few months. The trouble is Tom didn’t realise that his investment property was also secured by the main residence. The investment property is relatively new and hasn’t grown in value so the bank is insisting that $100,000 of the proceeds of the sale of the main residence be used to reduce the loan on the investment property.
Tom refuses and the bank refuses to discharge the mortgage on his main residence so his sale cannot settle.
Luckily there is a solution. Tom lets the bank keep $100,000 from the sale in a term deposit and to use this as security for the investment property (as well as the investment property mortgage itself).
Then when Tom finds his new main residence he will offer this as security for the investment property and the $100,000 will be released.
The 3rd example is probably the more common situation in which the cash as security is used.
There is a cost to doing this – When cash is used as security it will be in the form of a term deposit with an interest rate much lower than what the bank is charging. So, Tom may lose 3% in rate – get charged 5% for the loan, but receive 2% interest for the term deposit. There are tax consequences of this too as this would not be deductible.
But hopefully the use of a term deposit will be brief, and the benefits can last many years to come.
Only authorised deposit taking institutions will allow for cash to be used as security.
Written by Terryw broker at www.loanstructuring.com.au
Discussion at https://www.propertychat.com.au/community/threads/loan-tip-using-cash-as-security-for-a-loan.36038/
By law you are only required to keep receipts for about 5 to 7 years. But for tax this is 7 years after you claim an expense.
You should always keep your receipts just in case. If you move out of the main residence and rent it at some stage then the expenses incurred when you were living there can be used to reduce the CGT payable. However you may not sell the property for another 50 years so you will need to keep receipts this long if you want to save tax.
When someone dies and their property is inherited by someone else the cost base of the deceased will often be the cost base of the property for the person that inherited the property. So expenses incurred when the deceased was alive and living there or renting the property out can be relevant to the tax of the person that inherited the property.
If there is a capital loss that is carried forward receipts relating to the loss should be kept from at least 5 years after it has been used up in full.
Written by Terry Waugh, CTA & lawyer at Structuring Lawyers, www.structuringlawyers.com.au
It is impossible to reimburse yourself with borrowed money after an asset has been paid for and claim the interest
Interest will only be deductible if borrowed funds are used to produce income.
Where people get into trouble with this sort of thing is when they don’t plan ahead, but may pay a 10% deposit using cash before they have the loans sorted out. Once a deposit is paid in cash it is paid. If you later borrow an equivalent amount from a loan increase and ‘pay yourself back’ the interest on this loan cannot be deductible because the interest does not relate to a loan used for the property.
So, before you pay any money for a property make sure you get the loans set up so that you can borrow to pay for that property.
On a $500,000 purchase a 10% deposit is $50,000.
A $50,000 cash payment, while you have non-deductible debt on the main residence, will result in about $2,500 per year in lost deductions ($50k x 5%). That is per year for the life of the loan. That could cost the average person $1000 per year out of their pocket – enough for a trip overseas each year.
Written by Terry Waugh, CTA & lawyer at Structuring Lawyers, www.structuringlawyers.com.au