My wife and I currently own a house which is our principal place of residence. We purchased the property in 2001.
We are constructing a new home and are planning to move into the property when it is completed. This property is also in joint names.
We are considering keeping the existing house as an investment property.
We are considering to estabilish a hybrid trust for property investment.The trustee will be a registered company.
We are considering to sell our principal place of residence at market value to this trust. I will take out a loan from a financial institution to purchase units in the trust. The trust will use the money to buy our principal place of residence. I will be a unit holder and my family members will be beneficiaries.
My income and capital will be in the same proportion and the trustee can’t change this proportion.
I will pay income tax When the property returns positive income. I will pay capital gain tax(CGT) when i sell my units at market value.
1. Is interest incurred on a loan used to purchase units in the trust tax deductible?.
2. If the income earned from trust is less than the interest incurred, can i claim the entire amount of interest as a tax deduction?
The term hybrid trust refers to a trust that is somewhere between a fixed unit trust and a discretionary trust and usually has the ability to change. In most cases the ATO labels these trust discretionary trusts because there is always some discretionary power in the deed refer PBRs 65710, 66594& 71023. If your hybrid is considered a discretionary trust by the ATO then the interest to purchase the units will not be tax deductible.
Due to the infinite variety of hybrid deeds I cannot advise you specifically on your particular deed. You say that the trustee can’t change the fact that your income and capital will be in the same proportion I assume this is an argument that your right to income is fixed so the interest would be deductible. Firstly, have a look at the deed, there maybe a power to issue units at a lessor value with the same rights or there maybe a right to the trustee to redeem your units at less than the market value of the underlying asset. In the later case the ATO argues the Fletchers case and the TR 95/33 principle, that as the units have very little chance of ever being positively geared there is a reason in addition to producing income, for entering into the arrangement so the interest must be apportioned generally a deduction is only allowed up to the amount of income received PBR66298.
All this aside, lets look at what you are trying to achieve. I assume it is simply an interest deduction for the equity you have in your old house. If that is all you want you could simply sell the house to a fixed unit trust then you would be entitled to a tax deduction for the cost of the units. A far better option than taking the risk of having a hybrid deed that the ATO may find some discretionary power in. Make sure you get good legal advice here. I have seen some firms using their hybrid deed as a fixed deed too.
A further issue you should consider is, are you entering into the agreement with the dominant purpose of a tax benefit and if so then Part IVA would void the whole transaction putting you back into the situation for tax purposes that you were in before you entered into the arrangement so again the interest would not be tax deductible.
There will no doubt be quiet high stamp duty costs associated with these changes. Some states allow transfers between husband’s and wives to be free of stamp duty though you may have to change it from 50:50 to 99:1 so that both names still appear on the deed. You could consider buying your wife’s half, at least releasing half your equity. Yes there is still the question of a tax benefit but the less contrived the arrangement the less likely the ATO is to apply Part IVA, though I strongly recommend you get a ruling first. You need to have a reason such as a disagreement on whether or not to hold the property so that the tax benefit is not the dominant purpose. Refer ID 2001/79