This transcript was generated automatically and may contain small errors.
The first primary benefit of the trust structure is the ability to distribute income and capital gains to beneficiaries. If you're going to use that equity for acquiring a deductible or income-producing asset, then that interest is deductible. Once you set up a trust to purchase a property, and if you've got a negatively geared asset, then you don't get the benefit of the gearing because a trust cannot distribute losses. The trust is a very unique structure. It has various tax benefits.
If you use it properly, it has a multitude of benefits for you. In today's episode, we're catching up with Rinesh from the Incentium Group. Now, Rinesh's accounting background and expertise, and the work he's done with many of our clients at InvestorKit, is all going to be in display today as we go into the world of equity loans and trusts. Now, it's really important that we go into these particular worlds to help you as an investor learn more, but be more compliant and understand the way you're scaling your portfolio in the right way from a tax perspective. It's mistakes that people make so often, it stresses their accountants out, and if anything that comes up in terms of tax rules, are you following it or not, this is the episode to tune in and learn more about, especially when it comes to growing a portfolio using equity and using trusts.
So make sure you stay to the end. We will uncover more on trusts and even the thresholds because we've had some interesting learnings from Rinesh on discretionary versus family trusts and the thresholds there for tax in investing in, say, New South Wales as an example. So tune in, stay until the end where we cover off more, but most importantly, remember, when it comes to accounting, this is a general chat and it's not your personal or financial advice. Go speak to an accountant, speak to a financial planner to make sure you're educated on all the rules as they're constantly changing, and even this time that you watch this episode, things could be different weeks, days, months later, so go and get that advice. But for now, let's tune in.
Nerd alert! Property nerds, the home for data-driven property investors, where we uncover Australia's hot and cold markets, latest headlines and trends. Rinesh, welcome to the show, my friend. Thank you, Arjun. Thank you to the team at InvestorKit, Jack and Adrian.
Nice to meet you guys again. Yeah, well, we catch up often and we talk a lot of things on client scenarios. We pick your brain often, and this time we've actually got a lot of questions submitted from clients, our team, just to make sure we're sharp as possible in the world of accounting and getting your expertise here. But one of the most common things is equity and equity loans in particular. So when it comes to people taking out equity loans and then looking to, I guess, invest or maybe do other things with it, what are the most common mistakes you see when it comes to people taking out equity loans from an accounting and tax perspective?
Sure, sure. That's a very good question. We see quite commonly, you know, people are talking about equity in their own homes and their friends and their brokers say there's equity, you should be able to access that. So that's entirely not a free pool of money. It's still going to be, you know, a loan that you need to service and it's a debt that needs to be paid.
So it actually comes down to the end purpose of that equity. If you're going to use that equity for acquiring a deductible or income producing asset, then that interest is deductible. Whereas if you're going to use that equity for, for instance, a lifestyle purchase, you know, purchasing a car, your favorite Lamborghini or something like that. Or a boat. Or a boat.
Yeah. So then that equity, the connection to an income producing asset is not there anymore. So you can't claim that interest. So it's all about structuring your equity correctly. So you need to make sure that you've got a proper documentation around when you're extracting that loan from your property, making sure that it's connected to the income producing asset.
There is a document linking the connection for it. So that is what I think is one of the implications. Yeah. Getting that purpose right seems to be the common theme, right? Just making sure you're not spending it on things that you say are income producing but aren't.
And then you're not spending it on things that aren't the assets that income produce, but then you want it to be a tax deduction, right? So very fair point that it comes down to the purpose. Yeah. So people don't really know this, but could you speak to a little bit about the difference of accessing equity on an owner-occupied property versus accessing equity on an investment property? Because I know a lot of people have the preference to say when they want to purchase an investment property, oh, I want to access the equity in my investment property.
But you've got a lot of equity on your own occupied property. You can still access it from there because like you said, it's all based on the purpose. So could you talk to conversations you've had with clients about that? Yes. So we've had conversations of our clients for both investment and owner-occupied.
It comes down to a few things to consider. It comes down to risk, comes down to tax deductibility. Also, it comes down to serviceability of the debt as well. So where entirely, if you're focusing on one, then you're kind of most probably not achieving your entirely balanced goal. If you consider all three with respect to your situation, your financial situation, the assets you want to acquire, and the deductions you want to achieve, and again, the negative gearing, if there is, that's going to impact your personal tax situation or your other entities.
All of that has to be considered in totality rather than just focusing on one aspect, if that makes sense. Jack, coming to you on this one, when it comes to equity loans from an owner-occupied, does the bank look at that differently from a servicing perspective? They go, oh no, you took it out from there, so we service it differently? Or do they look at it more on, again, purpose-based, similar to what Rinesh is saying? So it comes down to negative gearing.
So if you're accessing an equity loan on your own occupied property, if you're using it for an investment property, they'll still allow you to negative gear that in the servicing. Got it. So it's all based on the purpose. Purpose seems to be the common theme. Unless it's being used for a property in the trust, they don't allow you to negative gear that.
Which is, that's another can to open up, eh? Yeah, I think now that we've talked about equity, I think what we see a lot in the strategies that we build out is people constantly tapping into equity, usually, I mean, the first time, but also it can be multiple times in creating multiple loan splits, and things can get a lot more complicated. Jack and I were just talking earlier before about making sure that we're keeping track of the equity and everything like that, and it can get a little bit confusing. So from your side as an accountant, what's the best way that we should be keeping track of the equity splits, the loans, and all of the complexities of that? Just leave it up to the accountant, mate.
I'm trying to help him. That's a very good thing you pointed out there. A lot of people who actually tap into equity bundle all their loans into one home loan or one read-off facility. So that makes our life quite difficult from a tax perspective because we want to see clarity. We want to see which loan is connected to which property and the interest on those loans because it's a matter of deciding what is deductible and what's not deductible from a tax perspective.
So if you've got loans for personal and loans for investment in the one facility, then it's quite muddy and messy, and it's quite expensive for us to spend extra time trying to distinguish between the two. And again, the tax office is quite strict about that as well. Is there a way that you could pick up on that, though, when you're doing a tax return? If someone sends you a loan, it's like, what's the point where you figure out that, hey, you're trying to claim too much interest for what you paid for that? Is there a way that you can figure that out?
I don't know the technical side of doing a tax return, but have you seen that come up where a client just sends you a loan and you realize the loan is too much for what you basically paid for the property? Well, our accountants, our team of accountants usually analyze the loan statements, and where we pick up various amounts differing in terms of value, it's not consistent. So that triggers a bell to us, and we ask questions and queries to our client, what are these payments for? Where we see consistency, regularity, then we know that, okay, it's meeting the loan requirements, the loan schedule is correct at the end of the day. But that's a good question that you've raised.
I would further add is, we've got clients who usually think that they need to talk to their accountants at tax time, but that's usually not the case. So where the client has decided that they want to draw out equity, they should give their accountant a call, say, what are they using that equity loan for? What sort of asset they're purchasing? And we would guide them to say, do it this way, structure it in a correct way, make sure the funds go into the relevant assets, and you can see the trail from the origination to the actual purchase of the asset. Are there any tips you have when people are structuring bank accounts or ways to present statements or things like that when it comes to equity management?
For example, someone with five or six properties, do you have the system where you go, okay, multiple offset accounts or not, Same journey or listening to us, you're like, oh, that excites me because I just figured out something. That's really helpful. Thank you for sharing, Rinesh. Let's be honest. Spreadsheet fatigue is real.
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Head to investikit. com. au. Link in the show notes. So when cashing out, like you have a property that you own in your personal name, you do a cash out loan to purchase a property that's in a trust, what are some main considerations for clients to consider?
Maybe some background about the technical side of being able to claim the interest within that trust. What are some of the things to consider there? So you can certainly draw equity from your personal home to fund the deposit for a purchase in a trust. Here, the ownership of the property lies in the trust, but the loan is actually in your personal name. So there's a distinction here.
The ATO definitely wants to look at the connection between you personally drawing that loan and then lending it to the trust for its purchase. So here we should have a loan agreement in place. We should have the trail of the money going from the personal loan to the trust and then for the purchase of the property. So that's number two that the ATO usually wants to see. There's a clear trail for it in your personal name because you've got a loan, you've drawn down the equity and you've loaned the money to the trust.
If you want to keep to the same interest rate, the deduction sits in the trust. So the interest deduction falls in the trust, but in your name it would be an interest income and an interest expense. So usually it would nullify and we would tend to keep the interest neutral in the personal name and claim the deduction at the trust level. Makes sense. That's a big one.
So people recognize that they're not increasing their interest deductions personally. They're nullifying that out because of the two vehicles and everything sits within the trust, which whilst it has a disadvantage against the personal claims, it has an advantage in the trust that once the trust as an asset, which likely you're purchasing in there, in future becomes positive cash flow one day, it's got a myriad of deductions that you can go against and use, right? Because that deduction has been carried over multiple years. Is that a fair understanding of that vehicle there benefiting you in the future, maybe just not right now? That's absolutely correct.
In most cases that we see, the trust usually has, you've got the property, you've got the loan, but the loan value ratio is usually quite high. So you've got a higher deduction of interest sitting in the trust, which ends up creating a negative gearing in the trust. So you've got losses accumulating in the trust. A trust cannot distribute losses, so they would accumulate in the trust until such point in time when you've got positive income in the trust or you do sell the property and you've got a capital gain, which can be used to offset against those losses. So those losses are quite valuable.
So you would definitely put through the interest expense in the trust accounts every year, accumulate it to that point where you start generating positive income and you can then use those losses. So those interest deductions are very valuable for the trust. On the topic of trusts, Rinesh, we have a lot of clients who are starting to continue to build their portfolio. They're looking to expand and they're starting to think about whether trust makes sense for them. Now, you deal with a whole bunch of clients and you are constantly assessing whether it makes sense for a client to go down the trust path.
What are some common traits, whether that's their financial situation, their profession, where you're going, hey, these are some patterns that I'm seeing where it might make sense to go into a trust? Sure, sure. It's always pros and cons of a lot of things, but it always comes down to your or to the individual's financial situation and their circumstances. One particular example would be where a person is growing in terms of income or they have a family and they have commitments. So you're looking at cash flow.
Once you set up a trust, again, to purchase a property, and if you've got a negatively geared asset, then you don't get the benefit of the gearing because the trust cannot distribute losses. Whereas if they had that asset in their own name, they would get the benefit of negative gearing against their PAYG income and get a tax refund when it comes to tax time. So you've got to consider overall your cash flow position. Are you able to fund that asset in the trust structure whilst not getting the tax deduction personally? So it's all about timing and also regarding your personal financial circumstances.
How much does having beneficiaries weigh on the decision to set up a trust or not? Because I think, just from my view, if someone doesn't have any beneficiaries, doesn't have any kids, doesn't have any parents, does that significantly reduce the efficacy of having a trust in the first place? In my experience and over the last couple of years, it actually hasn't. We've got professionals who are keen to go into the trust structure where they see the benefits in terms of being able to grow their portfolio and being able to acquire more properties. So it doesn't hinder.
They're not definitely hindered by the fact that they don't have beneficiaries, but they're looking at growth and a trust is a way that does achieve that. Well, to back up what you say, we've got single Adrian Lee here with no kids either, and he's all trusted up and everything, and he's working through all these structures. So without even pointing that out, you're spot on, like real life scenario right here, him going through that. And yeah, I mean, that's a very good point. So sorry if I just shouted out to all the ladies there, Adrian.
Look, Rinesh, thank you so much. It's a pleasure having you here today because the world of equity loans, the world of trust, they're not as simple just for everyone to comprehend and understand what goes on. And I think equity loans, there's so many common mistakes that happen without even people realizing that they're making them. So you gave them the real, I guess, cheat codes to focus on, which is don't get caught up on everything, just focus on the purpose. It's the purpose that matters, and the easier you can prove that purpose, the better is.
Now, Rinesh, how can people reach out to you? Because we work closely with you a lot at InvestorKit as does Foreca Financial from setting up trust, setting up SMSFs, managing accounting, just because of your holistic guidance on property as well as accounting. It's not so much just solely that you understand both worlds. How can people reach out to you in terms of your team to get support from the accounting perspective? Sure, sure.
We're always there to help clients of InvestorKit and Foreca and to the public out there. We've got our website, Incentive Group, and people can go onto the website and click on our client contact form and send it through their details. We're always happy to have a complimentary chat with them and to understand the situation and how best we can help them out. So yeah, feel free to click on our web link. Amazing.
Thank you so much. We'll chuck that on the show notes. And for everyone tuning in, if you've stayed this long, you're well and truly a property nerd. So we thank you and appreciate you. Have a good one and catch you on the next show.
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Game over.
