Trusts v LAQCs: Which is best?

What is a trust?
Trusts are used to protect assets for individuals and their families, preserving them for the future. The concept of a trust has been around for centuries. They are most commonly created by a deed which contains the trust's terms.

A trust is a fiduciary relationship – not an entity in its own right. Under a trust structure, the trustees hold titles to trust property in their own names but must manage that property for the benefit of the trust's beneficiaries. The law requires that the trust property must be kept separate from the trustees’ own property.

Assets may be protected by transferring ownership from an individual to a Family Trust. There may be benefits for your family home to be owned by a trust such as protection of assets for future generations or against creditors and asset testing.

If you own a rental property should it be transferred into a Family Trust?
This will depend on what you wish to achieve with your Family Trust and asset protection plan. Eg: Is it an asset you intend to keep and wish to protect?

However, where a rental property that has increased in value over a number of years, is either sold or transferred to a Family Trust (or anyone) an income tax liability can arise on the previously claimed depreciation being recovered.

If a rental property is making a loss, a trust may not be the most efficient vehicle to own the property from a tax perspective. The reason for this is that trusts cannot pass losses on to individuals for tax purposes (although rental losses can be offset against other trust income e.g. interest or dividends). Any losses incurred are carried forward and offset against future trust income.

What is a company?
A company is a separate legal entity. Under a simple company structure there are shares which entitle the holders to receive dividends and surplus assets when the company is wound up. One of the benefits of a company structure is that the shareholders are not liable for the company's obligations.

If a company meets certain criteria it can have a tax status as a Qualifying Company, or a Loss Attributing Qualifying Company (LAQC). A Qualifying Company maintains the benefits of a company structure while receiving some of the tax attributes of a partnership. An LAQC passes on any losses it makes to its shareholders (in the same proportion as their shareholding), and they can offset these losses against their other income. If a company elects to be treated as a Qualifying Company or an LAQC, the shareholders are liable for the company's tax obligations.

Why do people use LAQCs and when are they appropriate?
People often use LAQCs as a vehicle for owning rental properties where the property investment is anticipated to make a loss in the short term. Although holding ownership in personal names may achieve the same tax outcome, an LAQC has the advantage of limited liability.

Another benefit of LAQC ownership is that should you wish to transfer ownership of the investment to a Family Trust as part of your asset protection plan, this can be easily achieved by transferring ownership of the LAQC shares to the trust. Claw-back of depreciation is not an issue under these circumstances because it is the shares of the LAQC that are transferred to the trust, not the property owned by it. Advice should be obtained before the LAQC shares are transferred as the transfer may impact on the company's ability to maintain its LAQC status.

Establishment costs of an LAQC start at around $400 and annual fees from around $500. It is considered particularly worthwhile to have professional input from the beginning when setting up an LAQC. The costs (especially the annual ones) need to be taken into account when considering this type of ownership structure.

Do you need a trust if you have an LAQC?
This will depend on what you are trying to achieve with your asset protection plan. Trusts are an excellent way of helping you protect your personal assets (i.e. family home and investments). If your rental property investment is one that you wish to protect, the shares in the LAQC can be transferred to a trust.

If you plan to make a living by buying properties and on-selling them, should this be done through a trust?

Trusts are often used in this scenario to ensure that the trading or development activity does not taint the way other personal or investment assets are taxed; and are generally referred to as Trading Trusts. One of the benefits of a Trading Trust structure is the flexibility it offers in regard to the distribution of funds. Inland Revenue looks carefully at Trading Trust structures. It is therefore important to obtain professional advice before considering this as an option.

For more details on asset structuring see buy the NZ Property Magazine. The magazine is running a series designed to help property investors understand, in more detail, the pros and cons of various structures. To order your copy call 0800-345675.

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