6 Family Trust Advantages and Disadvantages

It’s a sad reality that many investors don’t think about the best ownership structure for their portfolios when they start their property investment journey.

While owning your assets in your own name is an option, you may want to consider a few more of the options out there when it comes to ensuring that your family interests are protected too.

Family trust structures are widely popular when it comes to asset protection benefits, tax benefits, managing family businesses, and your family members’ financial interests. Establishing a family trust can protect assets from bankruptcy, lawsuits, and individual trustee liabilities.

However, as with all investment strategies, you must consider many family trust advantages and disadvantages before opting for a trust structure strategy for your family group.

So, here are six family trust advantages and disadvantages that factor in when making your investment strategy decision.

What is a Family Trust?

A family trust is a type of discretionary trust set up to manage a family business or hold a family’s personal or business assets.

Family trusts are discretionary in nature because the trust deed authorises the trustee to exercise their decision making independently. This means that the trustee can exercise their discretion when deciding how to distribute the trust capital and income among the beneficiaries.

One option is to appoint a corporate trustee, such as a company, which offers benefits like asset protection, liability limitation, control over distributions, and succession planning.

The most common reason that Australians set up family trusts is to have some level of asset protection. However, there are a few other reasons why investors opt for a family trust structure, including:

• to purchase an investment property,
• to manage how family income is distributed, and
• to buy business assets.

Trust Advantages and Disadvantages For Your Family Members

Family trusts have significant advantages if they’re set up correctly and used efficiently. However, there are also a few potential disadvantages that you’ll need to weigh up. 

A key aspect to consider is the family trust election, a voluntary declaration to the Australian Taxation Office that can provide tax benefits such as passing franking credits and accessing concessional rules, but also imposes special tax charges on distributions made outside the family group.

Tax Advantages with Effective Tax Planning 

Because a trustee has the flexibility to distribute income as they deem relevant, they can make income allocations according to each beneficiary’s tax circumstances, ensuring that beneficiaries pay tax on the distributed income based on their personal marginal tax rates.

The most common way of utilising a family trust as an effective tax structure is to distribute more income to beneficiaries with a lower marginal tax rate because they’ll pay tax at a reduced amount compared to beneficiaries in a higher tax bracket.

By allocating income based on tax circumstances, the trustee can effectively minimise the general tax obligations of the family members who benefit from the trust. The trust itself does not pay income tax on distributed income, but it does have to pay tax on undistributed income at the highest tax rate.

Beyond effectively structuring income distributions, there are a few additional tax benefits for assets held in the family trust.

For example, suppose the family trust holds an investment property and rents it out to generate an income. If that’s the case, then the net rental can be distributed to the partner with no income, such as the spouse looking after young children or children over 18 years of age (perhaps attending university).

Where the property is held for longer than 12 months and is sold at a capital gain, the trust may be eligible for a 50% capital gains tax discount, which can be streamed to the beneficiaries. For example, this may be beneficial where one of the beneficiaries has a capital loss.

 

Estate and Succession Planning 

Many families also use family trusts to provide future income and succession planning by giving access to more capital when children become older. This could help support their studies, for example.

The family control test is crucial in determining the ability of the nominated individual, their family, or their legal/financial advisors to control the trust in specific prescribed ways as per the trust deed.

And when it comes to estate planning, the family trust structure enables parents to pass on control of the trust to the next generation.

The purpose of establishing the family trust structure is to avoid having to transfer assets among the beneficiaries according to a Will – which may trigger CGT and stamp duty. Instead, if a parent passes away, the assets are retained in the trust and the beneficiaries can continue deriving benefits from the family trust.

Consulting a tax advisor like us at Property Tax Specialists in this regard would be in your best interests.

Asset Protection 

Using a family trust as an ownership structure for your assets means that you won’t be the legal owner of the asset, which could help protect assets from crisis states such as unrelated bankruptcy.

Because the assets are held in the trustee’s name, not your own, the property is protected from creditors if one of the beneficiaries goes bankrupt or is the subject of legal action.

While this doesn’t mean you should set up a family trust to defeat creditors and their rights, the creditors will face hurdles to use the trust assets to settle any debt you owed if certain conditions are met.

Disadvantages of Assets Held in a Family Trust

As with any investment or asset protection strategy, you need to consider all the potential risks of a family trust structure concerning your financial and family circumstances. 

Tax Disadvantages

While you could effectively structure your family trust distributions to benefit from lower marginal rates, there are a few tax disadvantages you need to consider.

For example, undistributed income earned by the family trust could be taxed at a high marginal tax rate, and distributions to minor beneficiaries (under age 18) are taxed at rates up to 66%.

However, family trusts can also provide access to capital gains tax concessions and other tax concessions, though there are limitations in accessing certain government grants and tax concessions.

And, in some states, owning properties through a family trust means that your property may not be eligible for the tax-free land threshold.

 

Loss of Ownership of Assets Held in the Family Trust

You won’t have personal ownership of those assets because you’re using the family trust as a vehicle to purchase and hold assets. The trustee is the legal owner of those assets.

Losses Can’t Be Subtracted From Your Income

Suppose you own family assets under your own name, and it’s running at a loss. In that case, your property would be negatively geared, and the Australian Tax Office (ATO) would allow you to offset the loss against other income. 

So, you can deduct the loss from your assessable income, resulting in a reduced taxable income.

However, if your trust assets run at a loss, you can’t subtract these losses from your personal taxable income. 

The loss will essentially get trapped inside the trust until the trust generates enough income to cover the loss. 

Key Takeaways

Family trusts are a great way to keep assets protected and tax obligations to a minimum.  But they also have some drawbacks that you should be aware of before deciding if this is the right option for your own situation. 

For example, you won’t be eligible to claim negative gearing concessions if your trust assets run at a loss. 

However, it’s worth noting that there’s no one-size-fits-all approach to the advantages and disadvantages of a family trust because it all comes down to your family’s personal financial interests and circumstances. 

So, if you would like to determine whether a family trust is a suitable option for you, it’s ideal to consult with a tax specialist or financial advisor for advice. 

At Property Tax Specialists, our primary focus is helping property investors maximise their opportunities and protection while legally minimising their tax liabilities to grow their wealth

To discuss any matter relating to structuring your rental investments, protecting your assets or arranging your affairs for minimum tax, get in touch today.

Disclaimer:

Please note that every effort has been made to ensure that the information provided in this guide is accurate at time of writing. You should note, however, that the information is intended as a general guide only, providing an overview of general information available to property buyers and investors. This is not intended to be an exhaustive source of information and should not be seen to constitute legal, tax or investment advice. You should, where necessary, seek your own advice for any legal, tax or investment issues raised in your affairs.