Buying investment property through a trust: how it works

A lot of investors hear “buy through a trust” and assume it is something complicated that only wealthy people do. It is not that complicated. But it does come with real trade-offs that most guides gloss over. Here is a straight account of how it works, what it costs, and when it actually makes sense.

What is a discretionary trust?

A discretionary trust (also called a family trust) is a legal structure where a trustee holds assets on behalf of a group of beneficiaries. The trustee decides each year how to distribute the trust's income among those beneficiaries. That discretion is the whole point: income can be directed to whoever is in the lowest tax bracket that year.

The key people in a trust are:

• •Trustee: the legal owner of the assets, responsible for managing the trust and signing all contracts including the mortgage. Usually a company.
• •Beneficiaries: the people or entities who receive income distributions. Typically family members, but can include other companies or trusts.
• •Appointor: the person who has the power to remove and replace the trustee. This is the real position of control in a discretionary trust.
• •Settlor: the person who establishes the trust by transferring a small sum (usually $10) to the trustee to create it.

A unit trust works differently: beneficiaries hold fixed units (like shares) and income is distributed proportionally. There is less flexibility, but unit trusts are often used in joint venture arrangements where partners want a defined split.

How trust income is taxed

When a trust earns rental income, the trustee distributes it to beneficiaries and each beneficiary pays tax at their own marginal rate. If a couple owns a property personally and one earns $200,000, all the rental income gets added to the higher earner's return. Through a trust, the same income could be distributed to a spouse on $60,000 or to an adult child with little income.

This flexibility is most valuable when the trust is positively geared, earning more in rent than it costs to hold. For negatively geared properties, the story is completely different.

The trade-off: losses stay inside the trust

This is the part most people miss. When a discretionary trust runs at a loss, which is common in the early years when interest costs are high, those losses cannot be distributed to beneficiaries. They are trapped inside the trust and can only be offset against future trust income.

If you own the same property in your own name and it runs at a $15,000 annual loss, you reduce your taxable income by $15,000. On a 37% marginal rate, that is a $5,550 tax saving each year. Through a trust, you get nothing until the trust becomes profitable.

For a property that will be negatively geared for 5 to 10 years, this is a significant cost. Model it out before committing to the structure.

CGT discount in a trust

When a discretionary trust sells a property held for more than 12 months, it can access the 50% capital gains tax discount before distributing the gain to beneficiaries. Each beneficiary then pays CGT at their own rate on their share of the discounted gain.

This is one of the genuine advantages of a discretionary trust over a company. A company pays 25% or 30% corporate tax on the full capital gain with no discount. A trust that distributes to beneficiaries on lower marginal rates can produce a substantially better outcome on exit.

Land tax: the hidden cost most investors overlook

This is where trusts can get expensive, and it varies significantly by state. Individual property owners generally receive a land tax-free threshold in each state. Trusts often do not.

Land tax rules change regularly. Verify current thresholds with your state revenue office or a tax adviser.

In New South Wales, a discretionary trust gets no land tax threshold at all. A property with land value of $800,000 would incur land tax from dollar one, at 1.6% plus a flat $100, which comes to roughly $12,900 per year. The same property owned personally would pay nothing until the threshold is reached. That is a real cost that needs to go into your cash flow model.

Victoria applies a 0.375% surcharge to discretionary trusts on top of standard rates unless a trustee declaration is lodged to nominate a single beneficiary as the deemed owner (which removes the trust's income flexibility).

Getting a mortgage through a trust

Most major banks lend to discretionary trusts, but the process is more involved than a standard mortgage. The trustee is the borrower of record on the loan. If you have a corporate trustee (a company), the directors of that company sign as guarantors personally.

A few practical points worth knowing before you start:

• •The contract of sale must be signed by the trustee in its correct legal capacity, for example 'ABC Pty Ltd ATF The Smith Family Trust'. Getting this wrong can create costly amendments at settlement.
• •Lenders require a copy of the trust deed, the corporate trustee's ASIC registration, and sometimes a solicitor's letter confirming the trust is valid and the trustee has power to borrow.
• •Some lenders apply stricter serviceability assessments to trust loans, particularly if the trust has multiple income sources or beneficiaries.
• •LMI (lenders mortgage insurance) is generally not available for trust loans at most major lenders, so you will typically need a 20% deposit.

Asset protection

Because the trust (not you personally) owns the property, a creditor pursuing you personally cannot automatically claim trust assets. This is the asset protection argument for trusts, and it is real. It does have limits, though.

If you are a personal guarantor on the trust's mortgage (which you almost certainly will be), the bank can still come after your personal assets. And courts can look through trust structures in some circumstances, particularly in family law proceedings. A trust is not an impenetrable shield. It is a reasonable layer of separation for business and personal liability, not a strategy to frustrate legitimate creditors.

What it costs to set up and run

These are typical costs for a discretionary trust with a corporate trustee in Australia:

Total setup cost is usually $2,500 to $5,000. Ongoing costs are $1,800 to $3,000 per year. Those costs need to be covered by the tax saving the structure produces. For a property that is positively geared and distributing income to lower-rate beneficiaries, the maths can work well. For a negatively geared property with no distributions, you are paying these costs with no offsetting benefit.

When a trust actually makes sense

A trust tends to work well when:

• •The property is positively geared or will become so within a few years, and there are beneficiaries on lower tax rates to receive the distributions.
• •You are building a portfolio of multiple properties and want to hold them in separate trusts to manage land tax thresholds and limit cross-exposure.
• •Capital growth is the primary goal and you expect a large gain on exit that will benefit from the CGT discount distributed to lower-rate beneficiaries.
• •You have a genuine asset protection concern, for example you run a business with liability exposure and want your investment assets separated.
• •Your accountant has modelled it and the net benefit (after land tax, setup costs, and trapped losses) is positive over your intended holding period.

A trust is generally not the right structure when the property will be negatively geared for many years and you need those losses to offset your salary. It is also a poor fit if you are in NSW or Victoria and the extra land tax and stamp duty cost erases the income tax saving. For a full comparison of all structures, see entity types compared.

How ProfitPie models trust ownership

When you select a trust entity in ProfitPie, the model adjusts several things automatically. Losses are not offset against personal income; they accumulate inside the trust until the property turns cash-flow positive. Income is taxed at the beneficiary's marginal rate rather than the owner's. Land tax is recalculated using the trust rate for whichever state the property is in. And the CGT calculation on exit applies the 50% discount before distributing the gain.

You can run the same property under personal ownership and trust ownership side by side. The 30-year projection shows you the crossover point: the year at which the cumulative trust benefit overtakes the negative gearing benefit you gave up in the early years.

Common questions