The Transfer of Property From a Discretionary Trust to a Beneficiary

0:00
You're listening to Explain That by Velocity Legal, the podcast that keeps business owners and professional advisers ahead of the curve in an ever-changing legal landscape.

Well, there's a rising trend among Victorian property owners. They may have purchased a property in a discretionary trust and are now realising that there's a lot of tax issues with that, and that those property owners are looking to actually get those properties out of a discretionary trust.

0:26
The good news is that there may be a duty exemption available for those situations, but there are traps, there are pitfalls and you need to be very careful.

Today I'm going to be talking about transferring a Victorian property from a discretionary trust to a beneficiary and how to get that exempt from duty, and what else to consider.

0:45
I'm joined by Associate Tom Warrington, who's a tax lawyer within Velocity Legal's Tax team.

Welcome, Tom.

Thanks, Andrew. Appreciate it.

So Tom, in your practice, have you seen this as a rising trend or a common occurrence that there's property in a discretionary trust and the owners are looking to sort of restructure that out?

1:05
Yeah, absolutely. I think it's becoming more and more prevalent.

I think with the recent COVID pandemic and the COVID debt repayment plan from the Victorian Government, and the land tax just increasing dramatically in Victoria, especially for properties that are owned in trusts and the surcharge rate that comes with that.

1:25
Properties in discretionary trusts are looking a lot less attractive for people because those costs are just ramping up on an annual basis.

So the asset protection benefits that people often, you know, the reasons they put them in the trust, that isn't looking as attractive anymore when you've got this incredibly high land tax coming in.

1:45
So yeah, more and more common I think to think about, okay, how do I get this out of the trust and can I do it without massive tax implications?

And yes, we've seen quite a few people come in recently with this very question.

Yeah. And of course, if they can't do it without massive complications or costs, then maybe they won't do it.

2:05
But if it can be done in a not too painful way, then, as you said, there's those land tax savings, which, you know, if the property's owned in a trust, maybe you've got surcharge rates.

Yeah, values have gone up. And if it's their main residence then, well, I can't get it exempt from land tax.

2:22
Yeah. What's it doing in a trust anyway?

Yeah, if it's your main residence, you know you missed out on that main residence exemption in the future when you do come to sell the property.

Yeah, CGT.

And then there's, of course, vacant residential land tax complications.

Absolutely, yeah. Especially with the holiday homes nowadays, you know, people with properties down in the Mornington Peninsula, Bellarine Peninsula, vacant residential land tax is now such a consideration.

2:45
You know, if they've owned the property for a long time, they might have that exemption, the holiday home exemption.

So all these factors, I guess, are weighing up right now that are contributing to this question of, like, in Vic, putting properties in trusts, you know, it's really not very attractive anymore as a proposition.

3:04
Especially if they're living in it.

Especially.

I don't know if you've seen this as a common situation. You know, the individuals have lived in Melbourne. They had a place in Melbourne, and then they've bought somewhere else in a holiday-type location. They bought that in the trust because, you know, that's the advice they got at the time.

3:22
Yeah.

But now, you know, they've retired maybe, or they want to move to that holiday location full time.

Yeah.

Is that sort of one of the trends you're seeing?

Absolutely. Yeah. You're seeing that quite often recently.

And I think, you know, today we're going to talk a lot about duty and that duty exemption.

3:42
Obviously, when you do get this property out of the trust, if that's what you'd like, because you want to move to your holiday home and set up on the beach for your retirement, duty is obviously a key consideration as to what the duty bill will be to get this property out.

But firstly, I just have to preface that CGT is also a big consideration. For these people who may have owned this property down the Peninsula for, you know, five, 10, 15, 20 years, getting this property out of the trust is also a CGT event and that will have a tax liability connected to it.

4:16
So if there's a significant capital gain in the property, expect a tax bill associated with that, completely separate to duty.

So if it is something that's quite long term, the property's been there for a while, make sure you are happy with the CGT that's going to come with getting this property out of the trust.

4:34
I think we've also seen, I think COVID was obviously, we had a lot of people fleeing to the beach and we had a lot of people purchasing properties down the Peninsulas in Victoria specifically, I'm just talking about, and the prices, I know in Victoria in those locations, went through the roof during COVID. 2020, 2021 was sort of the peak.

4:56
Yeah, it went crazy. You know, the growth was amazing down there.

So if people purchased it for those quite inflated prices during COVID, for example, and now they're thinking, oh, actually we don't want this property in the trust, this is expensive, you know, those prices have kind of gone down.

5:13
There might not be a capital gain at all.

There might not be a capital gain. And that's kind of my point is that now might be a good time, if you do want to get a property out of a trust, to look into it because that CGT bill might not be a factor, and we can just focus on the duty exemption.

Yeah.

And whether we can get rid of that duty for you, essentially.

5:31
It's a good point. And so it's important to not forget the CGT.

I guess moving to the duty, what people absolutely hate more than paying duty once on a property is paying duty a second time on a property, double duty, where essentially, yes, it's you or it's your trust, but it's still really owned by entities related to you.

5:51
No one likes that.

No, exactly.

And, you know, we're paying duty at what, 5.5% mostly.

5.5% for Victorian properties.

Properties rounding.

Your most Victorian properties round, you know, up to that $2,000,000 range. You've got 5.5%, so you know that's 100 grand on a $2,000,000.

6:08
Property, you want to be absolutely sure before doing it.

Yeah, because you've already paid $100,000 and you want to cough up another $100,000 as well in duty just to get the property out of the trust.

Now sure, land tax might be a lot, but is it going to add up to $100,000 in that extra duty payment you're going to make?

6:25
And who wants to give the government another $100,000 to get a property out of trust?

So another key consideration.

So I understand there is a duty exemption available for discretionary trusts to beneficiaries. But I do understand there's a few pitfalls and probably this case we've been talking about offline, Baullo, is probably the best indication of what not to do almost.

6:49
Yeah, yeah, absolutely.

So there is a duty exemption in Victoria, which is a nice exemption to have. And not all states do have this exemption. So we're very lucky in Victoria.

The requirements of the duty exemption are quite strict.

So firstly, you need to obviously pay duty when you first purchase the property.

7:05
Yeah, that's a given really.

Yeah.

Secondly, you need to have been a beneficiary of that trust that purchased the property at the time the property was purchased. Or you've become a beneficiary via becoming a spouse of an individual who's a beneficiary, or a stepchild or a de facto.

7:22
So there are ways of getting in, but essentially you need to be within that class of beneficiaries of the trust when the property is purchased.

If we're talking individuals, that's usually would be fine.

Yeah, normally not an issue.

So that, okay, the property needs to be distributed to you absolutely.

Again, not an issue.

7:38
But the key requirement that is the most tricky, and the one that has caused the most difficulties, is this idea that the transfer cannot be for any type of consideration.

So it can't be part of a sale or an arrangement in which consideration is involved.

7:57
And the courts and the tribunals have interpreted this idea of consideration more broadly, like the sale and a payment of money. Of course that's consideration and we can't have that.

But what is deemed consideration, the courts and like you've said in this case of Baullo, really focus on the trust and the beneficiary loans or liabilities that might be within a trust, and what happens to those beneficiary liabilities following after the property's been removed, and what does the trust look like after that property is removed?

8:33
Because I guess it's going to that consideration element, and you know, consideration really means doing anything whatsoever that gives any benefit back to the trust.

Yeah, exactly.

So yes, of course paying money. But I think the thing that we're talking about is more, well, what if liabilities are being eliminated from the trust?

8:54
Yeah, exactly.

And I'll just briefly run through that Baullo case, what were the facts, because I guess it kind of highlights what this consideration might look like.

So Baullo involved a father and son doing a property development, and they purchased it in their names individually first, in both their names, and then they got some advice.

9:13
They bought at auction, then got some advice that maybe it was best to put it in a trust. They wanted to do a development.

So they nominated a trust as purchaser, purchased the property. I think the father contributed the deposit and the duty amount.

Yep, the duty bill.

Sorry, bill to buy the property.

9:30
So he paid that in personally, and in the financials of that trust that purchased the property, it was recorded as a beneficiary loan.

Which is very common.

Very common. People chip in money to the trust and it's usually treated as a liability.

Of the trust.

Absolutely. So that's now a liability of the trust going forward. They purchased the property, the trust owns the property, but the beneficiary loan is owed to the father.

9:53
Now they decided, I think the son wanted to live in the property, one of the properties they wanted to develop and build two units. I think the son wanted to live in one of them.

So they said, okay, well, we want to utilise the main residence exemption, I guess down the track for him. Let's get this property out of the trust.

10:09
And they, as we've kind of discussed, they did the duty exemption application, which is required to the State Revenue Office. They did the conveyance to sell the property and distribute it out of the trust to the individual.

However, following the distribution, that beneficiary loan that was sitting in the trust financials, the updated financials, suddenly that loan disappeared.

10:36
It disappeared.

Yeah.

So you think, oh well, hang on. The trust has been enriched, essentially.

The trust has been enriched. The trust had a liability that they had to pay that was owed to the father, and suddenly that property has disappeared out of the trust and that loan has disappeared with it.

So the trust has been enriched. It no longer has liability.

10:54
So that is what the court in Baullo said. Well, that is a form of consideration because the father or the individual beneficiary, you know, they had money owing to them from the trust, and when this property was distributed to a beneficiary, they were no longer owed that money.

11:11
So there was a form of consideration, and it's something that's been found in quite a few cases, that these financials and how these financials are recorded following a transaction, any type of forgiveness or waiver of those beneficiary loans will be deemed to be a form of consideration.

11:30
So.

It's completely fatal, right?

That's not a rather duty exemption.

No, no, no. You lose entirely. You lose all the exemption application. You've gone through all the expense of getting the lawyer or someone to draft up the exemption application, and then, yeah, you're whacked with the duty regardless.

11:47
So it's something to take note of.

So the financials of the trust, how money was contributed to buy the property, how it was reflected in the financials, whether it was a beneficiary loan or even a gift.

So I think what we've seen in our practice a few times is that, you know, if I'm buying a property using a family trust and I'm the one controlling it, and I'm a beneficiary of the trust and I'm the director of the trustee and I'm contributing the cash to purchase the property.

12:14
You know, you don't ever expect that cash isn't coming out of the trustee. You know, sure, you're putting the money into the trust to buy the property, but the trust isn't going to pay you that cash back really until it sells the property.

So I understand reflecting it as a beneficiary loan, but another way to do it is to reflect it as a gift.

12:36
So in Baullo, let's say if they went and that deposit and that stamp duty were gifted to the trust at the very start, it might not have been an issue.

Absolutely. Because then there's no liability, I guess, owing to the beneficiary, any beneficiary that then gets distributed the property.

12:54
So you don't have that consideration concern.

Obviously that's not always feasible. Sometimes, you know, other people are chipping in money.

Yeah.

And they don't want it to be gifted. They want the money back.

And what about the situation where that loan, let's say, you know, it's a discretionary trust and it's got its property and it wants to distribute the property out, and there's already these liabilities there.

13:16
What about when the trust leaves those liabilities in the trust? So to say, property goes out, but the liabilities are left in the trust.

Yeah, that is a key consideration when thinking about whether you can distribute this property, because the trust might not just own this property.

13:33
A trust might do other things as well. So there might be other liabilities in that trust that the trust owes to someone or some individual. There's money owing.

If the property is a significant asset of that trust and the value of that property is removed.

13:53
If the liabilities remaining in that trust outweigh the assets remaining in the trust, well, then how are the liabilities ever being paid back?

You're sort of pulling the value out and there's sort of never going to be able to pay those liabilities.

14:08
They're never going to pay those liabilities, so the court, that is also then a form of consideration because the trust needs to have assets remaining to cover any liabilities that they have.

Excuse me, that they have left over following the transfer of that property.

14:26
So it's important to look at the financials and understand, well, what are the assets in the trust before we distribute?

If it's not just the property, if there are other things in that trust, financials might just reflect the initial cost of those assets, but what are the current market values of those assets too?

14:44
Because if we do the calculations and we remove the property and that value is gone and liabilities outweigh assets, well, then that's an issue.

But if the market value of those assets actually still outweighs the liabilities remaining, then we won't have an issue to distribute the property out and still get access to that duty exemption.

15:04
And some of these things are real planning things where, you know, I'm sure you've got situations where you advise clients years out that, okay, there's a problem now.

But with the right type of planning, yeah, or the wrong type of planning, you might have a problem.

15:19
Yeah. Because when we're doing this, you have to do a duty exemption application and lodge that to the State Revenue Office to essentially say we acknowledge this is dutiable.

You know, getting this property out is dutiable, but we think it essentially would be eligible for this exemption. And you outline why it satisfies those requirements of the exemption.

15:41
And as part of this, the SRO has evidentiary manual requirements that you need to provide them, specific things with this application.

One of them is three years worth of financials of the trust.

So when you talk about planning, this is something that, if you're looking to do the distribution of the property, there's mortgages connected, which I'm sure we'll talk about down the track.

16:03
There are loans, there are issues. You only need to provide them the last three years worth of financials.

So if there is some planning and we can do this more than three years potentially out, or just in advance, so the most recent financials you provide might look better, then we can do that planning, I guess, in advance to make sure there is no consideration issue.

16:27
There'd obviously be other reasons for doing those things which have nothing to do with duty.

So, you know, there might be very good reasons why doing it this way versus that way has other effects as well.

But yeah, you mentioned mortgages.

16:45
My question, what about bank mortgages?

I understand they're treated slightly differently.

Yeah. So like I said, you purchased the property in a trust, but it might have a bank loan and a mortgage registered with that property, you know, connected with that property.

17:02
You can't strip the property out of the trust and leave the mortgage.

The bank won't let you.

The bank won't let you. You can't have the mortgage and the property with two different proprietors. So the mortgage needs to come with the property.

Yeah.

So thankfully, even with this exemption, there's another section of the Act that essentially says that that beneficiary can actually assume liability over that existing mortgage in the property.

17:30
So you have to go to the bank and you'll need to do the necessary paperwork to essentially change the mortgage from the trust into your name and tick off all those, you know, jump through their hoops, unfortunately.

But the beneficiary can assume responsibility for that mortgage, and that is satisfactory to actually be able to distribute the property.

17:51
So the property doesn't need to be unencumbered to consider distributing the property out of a family trust.

Yeah. So you could theoretically have a bank liability there or mortgage registered that's assumed by the beneficiary. Yep, that won't cause an issue.

But beware if there's beneficiary loan accounts either being assumed or forgiven, or the trust sort of going underwater such that it doesn't have assets to pay those liabilities.

18:17
Absolutely. And this is why I think before, like all these traps we're talking about, there are lots of traps when you're doing this type of transfer of property.

So I think that's why, if this is something you're interested in, it's really important to get a thorough review from someone like us, a thorough review of your financials, the history of the property, what kind of capital gain you might be looking for.

18:44
What are the financials of the trust showing? What kind of liabilities do we have?

We need to tick off all those boxes to make sure that, you know, what are the liabilities they're going to come from? What's going to this property? What's it going to look like for you?

18:59
You don't want any unintended little bombs going off, that you suddenly get whacked with a massive tax bill from getting this property out.

So a thorough review is really important.

And is that what you normally do typically if a client comes to you and says, hey, we've got this property in the trust, we're thinking about doing this, which is your advice essentially that, look, before doing anything, we really need to review everything, make sure we're confident on the duty position, understand the CGT cost benefit, and then go ahead and pull the trigger.

19:27
Yeah, exactly. We don't want our clients to be surprised, and we don't want to incur costs preparing duty exemption applications.

Preparing, you know, to distribute a property out, you need to prepare a deed of capital distribution essentially, which is the vehicle that gets the property out of the trust to the beneficiary.

19:46
This takes time. It takes expertise, and then you also need to do the conveyance of the property actually, you know, selling the property, really distributing it from, moving the registered title over to the individual.

So all those things incur costs to actually get the property out.

So before we even start any of those processes and incurring those costs, we like to do that thorough review to make sure the client knows everything.

20:12
They know what's the duty, if they're going to be eligible, or we can advise them on are you going to get the duty exemption. What are the CGT liabilities like? What's the capital gain looking like?

And if we're happy, you're going to get the application and we can advise you on that.

20:28
If you're happy with the CGT or, you know, hopefully there's no CGT, even only at that point would we then be like, okay, this is what the implications are.

Would you like to do it?

Yes, yes.

Okay, well then now we can start the process of actually getting the property.

20:45
Having that comfort before going ahead, then you can have.

A problem?

Well, you don't want to get kicked back by the State Revenue Office.

Yeah. And if you think that there might be a problem, I guess it's more, there's a potential issue. Here are some options around how to maybe fix it. Maybe you've got to, you know, do other things, and there's options there, even if it is one that's a bit more of an issue.

21:09
Yeah, exactly. It might be a situation where there's a big mortgage on the property and you might not want to assume that mortgage, but you might have lots of cash in an offset account offsetting that mortgage.

And, you know, for flexibility, you may arrange your finance that way.

21:25
Well, if we look at that and we review that, we're like, well, if we can just pay that mortgage out with the offset account, then you don't need to assume, then we won't need to go through a process of assuming the mortgage.

And, you know, if you've got some equity in the property, maybe you can just draw down on that property once it's distributed into your name.

21:43
So there are ways that we can think about this process and plan and have those conversations to get what you're after.

Final question, Tom. Now this is an area where there's sort of a lot of myths and misconceptions.

21:59
What would you, and I'm going to ask just for one, not many, but what would you say the number one myth or misconception is with transferring trust properties out of discretionary trusts?

One of the myths, I guess, well, that you automatically get the duty exemption. That the main residence exemption would have, like some people do own these properties in main residence and have some reason a trust might own a main residence, and they think that it provides a shield of all tax liabilities that might happen with respect to that property.

22:35
Yeah. So that's a key misconception.

The main residence exemption is this mighty or powerful.

Yeah, tax free. These might be your main residence, but at the end of the day, if it's owned by a trust, it's not owned by you personally. You don't get the main residence exemption.

No.

22:51
Exactly. So we will get it going forward, starting from day one, if you know the CGT going forward once you distribute the property.

But up to that point, you didn't own the property, the trust did.

So yeah, I think, well, the key thing is that it's not some type of get out of jail free card.

23:07
Tom, I wanted to ask one final question.

In seeking advice on a stamp duty or duty exemption issue, why should someone be speaking to a lawyer rather than an accountant?

Yeah, it's quite a common misconception actually that accountants can advise on all the areas of taxes.

23:29
Unfortunately, their type of insurance and coverage of accountants doesn't actually cover them for advising on state taxes.

So technically, you should really seek the advice of a tax lawyer to get that advice on the duty exemption or any type of state taxes, payroll tax, land tax, etcetera, etcetera.

23:49
So it is important when you are thinking about state taxes. You can go to your accountant at first, your first call, to say if you do have questions.

But often the accountants will then pass you on to someone like us because we're allowed to properly advise on state taxes and how to proceed with something like a duty exemption application.

24:11
Yeah, yeah. And it's that intersection between legal and tax.

And state tax is different to federal tax.

Yes, yeah.

And we have to think about all the implications, state and federal.

Yes, yeah. And so we can do that for you.

Yeah.

Well, thank you so much for being part of this episode.

24:28
If anyone has any questions, considerations about properties owned with discretionary trusts and looking to get them out, I encourage you to reach out to Tom, and he's happy to have an initial discussion with you about that and your options.

Cheers.

Thanks, Andrew.