Mr and Mrs Smith recently came to see us because they had an annual land tax bill of $46,000 per annum to pay.
They were both medical specialists, so both were in high risk industries for litigation.
Naturally they were concerned to have anything in their name.
If you have nothing in your name than creditors are reluctant to take legal action, because even if they won there would be nothing for them except a large legal bill.
They were interested to buy a new home and under normal circumstances you would purchase the home in the name of the spouse who was less “at risk”.
For example, if the wife was a heart surgeon (highly risky for being sued) and the husband worked as a clerk at a bank (no risk at all), the house would be bought in the husband’s name.
Some may be worried that should the marriage not work out then the wife would be at risk of losing the family home because it’s in the husband’s name.
This is not the case. The Family Law Court have powers to “look through” any entity that is set up to avoid paying the spouse their rightful entitlement.
The Courts, when assessing how the family assets should be split up, look mainly at the welfare of the children.
As children are the ones who are generally the most affected when marriages break up, the Courts try to minimise the trauma to the children by maintaining as normal an environment for them as possible.
This would include ensuring the full time carer of the children retained the home so the children would stay in the house they were brought up in, attend the schools they were previously attending and retain the friends they had made. They also look at the earning capacity of each party and divide the assets up according to their needs so that it’s fair to all concerned.
In this case the husband was unable to work full time due to caring for their children and his part time job only earned him $28,000 per annum maximum.
However even after returning to full time work (once the children turn 18), his maximum earning capacity for full time work as a clerk may only be $65,000 pa and he may be 50 years of age by the time he returns to full time work. This does not leave him many years to save for his retirement.
However if the wife was a heart surgeon earning $1 million dollars a year, the assets would be split up (irrespective of who’s name the property was in), to reflect the above.
Namely the husband would most likely get the house and an allowance from the wife to raise the children and the remaining assets would probably all go to the husband to reflect the fact that his earning capacity and his career had to be put on hold whilst raising the family. Additionally, after going back to full time work he will not be able to accumulate assets anywhere near what the wife could, because she was able to continue on her career uninterrupted.
Hence he would get a larger slice of the family assets to take into account the imbalance that would arise in the remaining years until they both retire.
Now, back to the original story.
Mr and Mrs Smith are medical specialists and in highly litigious industries where they can both get sued, so they naturally did not want any assets in their own name and they were in the market for a new home.
They had visited one of the top 3 largest Accountancy Firms in the city who advised them that they should purchase their home in a Family Trust. As the property was held in a Trust it would be protected from litigation because the home was not in their name. While this is correct, it won’t safeguard the property from a divorce settlement. The only protection from a divorce settlement is getting a prenuptial agreement before getting married.
A year later Mr and Mrs Smith receive a land tax bill of $46,000 for this home. This will be an annual land tax bill for the rest of the time they owned that property.
If you own your own home and wonder why you have not received a land tax bill from the Office of State Revenue, it’s because under normal circumstances there is no land tax liability when the property is your home. However when a Trust owns it (this was a NSW case) it’s deemed an investment property subject to land tax.
In addition, Trusts in NSW do not get a land tax threshold so land tax is paid from the very first dollar.
They then visited 3 other large Law Firms in the city in an attempt to get a solution. They all came up with various “band aid” solutions to try and get them out of this problem. The solutions they provided went from converting the Family Trust to a Fixed Trust to qualify for the land tax threshold in NSW, thus reducing the land tax only by $6,000, to other elaborate schemes which cost them tens of thousands of dollars in legal costs but still did not eradicate the land tax bill completely.
They were contemplating selling the property when they were referred to us. They were understandably extremely sceptical when they came in for their meeting, already having accepted that there was nothing more they could do since they had been to the large end of town and paid over $50,000 in accounting and solicitor fees.
Our fee was $395 for a couple of hour’s consultation. They came to us from a referral who had told them that if they wanted property advice there was no one better, so reluctantly they came in.
We immediately advised them we could eliminate the land tax bill completely by the granting of a Life Interest back to them.
There was absolute silence and disbelief because “they had been to see so many others (quote) and no one could come up with an easy and cost effective solution.”
“Are you sure this is legal?” they asked.
In NSW one can grant a Life Interest to a third party and what they use the premises for will determine the tax liability. As it was used as their home, they could apply to be exempt from land tax. Naturally a life interest is an asset, so from an asset protection point of view we had to build into the agreement the granting that the life interest ceases to exist if they were sued.
Life interests are very common. The most common way that Life Interests are used is when someone wants their home to go to their 3 children but they may want their disabled child to live out their life in the house. So to protect this child from being thrown out by the other children a Life Interest is granted to the disabled child allowing her to stay until she passes.
There is no stamp duty in the granting of a life interest in NSW but there are different rules for different States. For example in Queensland stamp duty is payable. One must get individual advice before acting on this because everyone’s circumstances are different and there are different laws in the different States.
For any free advice go to “Ask the Experts” at www.chan-naylor.com.au
Ed Chan is founder Chan and Naylor, accountants, is a leading property tax specialist and has co-authored 3 best selling books. As a seasoned property investor he shares his unique understanding of the relationship between property investment and tax. Go to www.chan-naylor.com.au
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