That's a good question, and it depends a lot on what entity incurs the loss. Let's break down the various types and what effect they have.
Look-Through Company (LTC)
If you are a shareholder in a Look-Through Company (LTC) and that company makes a loss, then you get to carry that loss through to your personal tax return (usually an IR3). There are a few rules and limitations* which we won't go into at length here.
Let's assume you're a salaried employee, and so you've had PAYE deducted from your wages. Well, at the end of the financial year a wash-up is done on your personal tax return. The above-mentioned loss is deducted from your gross (pre-tax) wages. It might look something like this:
-$ 5,000 Loss from LTC which owns rental property
$ 4,000 Income from personally owned rental property
- - - - - - -
$85,000 Net taxable income
-$ 1,000 Rental loss to carry forward to next financial year
We then calculate (a) how much tax you have paid, and (b) how much tax you should have paid. If (a) is more than (b) then you get a tax refund. If the other way around, you have tax to pay.
Limited Liability Company (LLC)
Ok this situation is totally different. If the LLC makes a loss, then it can't be passed on to anyone. Not the shareholders, not the directors: no one.
Instead, it carries that loss forward to the following financial year. If there is taxable profit, then the loss can be offset against that profit. It might look something like this:
$85,000 Net taxable profit
-$ 5,000 Losses brought forward from previous years
- - - - - - -
$80,000 Net taxable income
If there is no profit, then you just keep carrying the losses forward, year to year.
If you have a trust it's the same as an LLC with respect to losses. They can't be distributed out to the beneficiaries. Rather, they get carried forward until there is profit to offset them against.
A partnership works in a similar way to a Look-Through Company essentially. Losses are distributed to each partner, according to the rules of the partnership.
Sometimes you might combine some of these structures.
For example, a trust might own all the shares in a Look-Through Company. The LTC makes a loss. What happens then? In this case, the losses flow through to the Trust. They are then dealt with as explained above.
In the meantime, please contact us with any questions, or talk to your tax professional.
* From 1 April 2019, tax losses will no longer flow through from LTCs that are residential land rich. Please contact us or call for advice on how to get the best results from your portfolio, build wealth and minimise tax
Your lawyer has possibly mis-advised you - although in good faith. Why do we say that? Well, here's a quick checklist before you start panicking:
The gist of it
Previously, the country's lawyers had advised people to gift no more than $54,000 per couple per year so that they wouldn't be accused of excessive gifting when it came time to be assessed for a residential care subsidy. If your assets come under certain figures the Govt. will subsidise your rest-home care. People generally gradually and cautiously gift their house to their trust so that anything they do doesn't stray into excess.
BUT! A recent series of court decisions, upheld all the way to the Court of Appeal, has now said
Gifts of more than $27,000 per year, per application made before the five year gifting period, may be added into the assessment. For couples, gifting is $27,000 in total – not per person.
See this page on the WINZ website for more info
What does this mean for you?
Here's what the Law Society of NZ said:*
The result of the High Court’s decision is that many people who have undertaken a gifting programme to a family trust may now unexpectedly find themselves ineligible for the residential care subsidy. This will come as an unwelcome shock to many. It will also likely cause many members of the profession concern at the prospect of claims from disgruntled clients for previous advice on gifting programmes.
The long and the short of it is that if you have already gifted more than $27,000 per annum to your trust, then this may now viewed by MSD as excessive gifting. (NB: If you have mirror trusts then you may be able to get away with $27,000 per trust per year). If you acted on legal advice, then I suggest you approach your lawyer about making a claim against them. The NZ Law Society makes this comment to lawyers:
Lawyers may wish to consider whether there is a need to notify professional indemnity insurers in respect of the risk of potential claims for previous gifting advice. Some brokers are encouraging practitioners to notify insurers of the risk of potential claims. Practitioners are encouraged to check their particular circumstances with their broker/insurer.
Note that lawyers throughout NZ advised people based on the then-understanding of $54,000 per couple per year, and so acted in good faith. But, at the end of the day, the advice has been misleading, as this recent judgement has shown. It's not pleasant for anyone.
Yes, but didn't the IRD change the law or something? What you might be referring to was the repeal of gift duty. What happened was that the Government passed a law change, meaning that you could gift your entire house to your trust, without incurring gift duty. Previously there was a limit of $54,000 per couple per year. Anything above that had gift duty applied to it. BUT (and here's the key point), the MSD's view of excessive gifting didn't change. If anything, it has tightened up, as explained above.
Residential Care Subsidy (WINZ)
FAMILY TRUST ACCOUNTING - WHAT DO I NEED TO DO?
TRUST LAW CHANGES NEW ZEALAND
What to know more? Call us on 0800 890 132 or email us.
* Note that the quoted blog post from the NZ Law Society is dated Jun 21, 2013, which was before the Appeal Court had made its ruling. This Court ruling confirmed MSD's view, as stated above.
See our three-video series:
SHAM TRUSTS: COULD YOUR FAMILY TRUST BE A SHAM?
COMMON RENTAL OWNERSHIP STRUCTURES
WHICH OWNERSHIP STRUCTURE SHOULD I USE FOR MY RENTAL PROPERTY?
And the following blog articles:FAMILY TRUSTS: BASIC CONCEPTS
FAMILY TRUST ACCOUNTING - WHAT DO I NEED TO DO?
COMMON MISCONCEPTIONS ABOUT FAMILY TRUSTS
Image courtesy of Idea go at FreeDigitalPhotos.net
What will the new tax rates in NZ mean for you? Now that the election is decided, there will be a new tax rate to deal with in 2021: 39% on personal income exceeding $180,000 per year.
These coming changes emphasize how important it is to have the right business and/or investment structures in place. There will be tax planning opportunities arising out of the difference between the trust tax rate (33%), the company tax rate (28%), the present top personal tax rate (33%) and the new top personal tax rate (39%).
If you would like a review of your tax position and structure, please complete the contact form below or call us on 099730706 line 2
Trust law changes: New Zealand. What are they, and how will they affect you and your trust?
The main changes are:
Now, you might already be doing this, but here are some more changes; the new law lists core documents that all trustees need to retain:
If you are a client of EpsomTax.com Limited, you already do this.* But if you don't have up-to-date financial statements for your trust, you will have a lot of work (and expense possibly) ahead of you (contact us for a quote on 099730706). That might be this lady's problem...?
Anyway, another big big change for trustees is that you will need to tell the beneficiaries info such as:
BENEFICIARIES BECOME SETTLORS - HOW?
Here is the jargon: Section 67 of the Taxation (Annual Rates for 2019-20, GST Offshore Supplier Registration, and Remedial Matters) Act 2019 enacts an amendment to section HC 27 of the Income Tax Act 2007.
That amendment provides that when a beneficiary of a trust is owed an amount by the trust, the beneficiary does not become a settlor of the trust if –
How do you know if one of your beneficiaries is owed more than $25,000 by the trust? The trust will need a balance sheet, at the very least, to track this.
What should you do if this is the case?
Yikes! So, some big changes coming. For a more detailed summary, please visit this page at Weston Ward & Lascelles Lawyers.^
* See a link to our blog articles on this subject here
^ This link does not constitute an endorsement of EpsomTax.com Limited by Weston Ward & Lascelles. Please contact them or your own lawyer for more information on what this means for your trust. EpsomTax.com Limited cannot provide legal advice; for accounting and taxation advice, please contact us.
It's a question we get asked from time to time: "My family trust only owns the house, nothing else. I've never had financial statements done for it; is it really necessary?"
Well, your lawyer may tell you no, we but our view is "Yes! Absolutely!" To explain why, please see this excerpt from from Family Trusts 101 by Janet Xuccoa, Chartered Accountant, GRA:
*** start of excerpt ***
It never fails to amaze me the number of Trustees that don’t have annual financial statements prepared for the Trust they are administering.
How can a Trustee meet one of their fundamental duties of accounting to a Beneficiary if they do not possess up to date financial knowledge of the Trust’s affairs? Furthermore, a Trustee has a duty to meet the tax obligations of the Trust and these obligations can’t possibly be identified and satisfied if a Trustee doesn’t know the financial position of the Trust. So in my view, the rule is financial statements should be prepared for Trusts.
Sometimes a Trustee will ask me if the above rule applies to a Trust which does not receive or earn income. I think it does.
If a Trust is a recipient of income then financial statements and tax returns must by law be prepared and lodged with Inland Revenue. If a Trust does not however earn or receive any income, then I still believe financial statements should be prepared because by doing so three things are established
First, the loans owed back to the Settlor/s (if any) can be identified and a correction (if needed) can then be made. Furthermore, a decision with respect to gifting can be formed.
Secondly, the assets and liabilities of the Trust will be noted in the financial Statements which helps Trustees conduct an Annual Financial Statement Review and an Annual Trustee Meeting. If you read ahead you will understand why this Review and Meeting are important and the role the financial statements play.
Lastly, by completing financial statements Trustees are put in a position of being able to meet the duties they owe to the Beneficiaries. In other words, the Trustees are able to account to the Beneficiaries and will be able to identify and satisfy the Trust’s tax obligations.
FINANCIAL STATEMENT REVIEW
I think a great aid in avoiding a successful sham Trust allegation is the performing of a Financial Statement Review. This Review should be conducted annually, once the financial statements for the Trust are to hand.
I recommend the Professional Trustee conduct the review. Once performed, the Professional Trustee should report back to their co-Trustees on the matters that need attention.
In particular, the financial statement review should cover:
Lastly, I expect a Professional Trustee’s review to determine what documentation, if any, is required to bring the administration of the Trust up to date. This could include the preparation of Resolutions, Deeds of Acknowledgement of Debt and Variable Interest Loan Agreements to name but a few documents.
*** end of excerpt ***
Buy The Book!
We thoroughly recommend purchasing Janet's excellent and easy to read book on Family Trusts. Click here to purchase. Thanks to Janet for permission to publish this information here.
The Two Main Types of Trust
There are generally two types of trusts that we do the accounting for:
A trust is an arrangement between three groups of people: the Settlor, the Trustees and the Beneficiaries. The Settlor of the trust sells his property to the Trust. To acknowledge this, a Deed of Acknowledgement of Debt is usually drawn up. The Trustees must then manage the property on behalf of the Beneficiaries of the Trust. (Any legal documents including bank statements should actually be issued to the Trustees, but sometimes you will see bank statements and invoices issued to the Trust). A person may be the Settlor, a Trustee and one of the Beneficiaries.
Now, usually the Trust has no income, so the Settlor pays the mortgage to the bank on behalf of the Trust. This creates more advances (loans) from the Settlor to the Trust. Usually an Agreement to Occupy is drawn up, and this basically says that the Trustees can live in the house rent free, so long as they pay for the upkeep of the property.
Note that if the Settlor (assuming he is living in the house and is also a Trustee) does improvements on the house, then this is also considered an advance to the Trust (this is because it is not the sort of an expense that a “tenant” would pay for; rather, an improvement is a landlord’s expense and in this case the Trust is the “landlord”, even though no rent is charged to the “tenant”).
This is where gifting comes in: the Settlor is owed money by the Trust (he sold the property to the Trust) but he decides to progressively forgive this debt, usually no more than $27,000 per year (here’s why people usually don’t gift more than that amount). This gifting is recognised by Deeds of Forgiveness of Debt, which are typically drawn up annually. In the past these had to be registered with IRD but not anymore. Sometimes the Settlor will forgive all of the debt at once. The decision on whether to do this or not is best taken under legal advice.
Why do people set up trusts?
The benefit of a trust is that a person gets to use its assets, thus controlling them, without having legal ownership of them. People do this to protect themselves from being sued by creditors and losing everything. Most commonly people put the house they live in into a Trust.
Here is everything we’ve written on trusts:
Please feel free to browse; there are a couple of videos and articles which you’ll find helpful.
Where to from here?
We hope that this gives you an overview. For more information please contact your lawyer.
In this, the third of three videos in the series, Garreth Collard, Principal of EpsomTax.com addresses APIA members on the Sham Trusts. Learn about how your "family" trust might be a sham, what this could mean for you, and how to prevent (and fix) the situation! The video is 12 minutes long, so make sure you're comfortable...
Click here for a copy of the handout being used at the presentation. The other two videos in the series are:COMMON RENTAL OWNERSHIP STRUCTURES [VIDEO]
WHICH OWNERSHIP STRUCTURE SHOULD I USE FOR MY RENTAL PROPERTY? [VIDEO]
You might also be interested in:
COMMON MISCONCEPTIONS ABOUT FAMILY TRUSTS
FAMILY TRUST ACCOUNTING - WHAT DO I NEED TO DO?
RESIDENTIAL CARE SUBSIDY AND GIFTING
If you've got 5 minutes, make yourself a hot cuppa and enjoy this video presentation by Garreth Collard, Principal of EpsomTax.com in which he addresses APIA members on the pros and cons of the most common Rental Ownership Structures. Click here for a copy of the handout being used at the presentation.
See this insightful 3-minute video presentation by Garreth Collard, Principal of EpsomTax.com in which he explains the nuts and bolts of the most common rental ownership structures to APIA members. Click here for a copy of the handout being used at the presentation.
Disclosures: EpsomTax.com does not claim endorsement by APIA. Garreth Collard was invited to speak to APIA members by APIA. Garreth was not remunerated for this.
Note: Some partnership agreements do allow annual adjustments to distribution of losses/profits; check the wording of your agreement with your lawyer if you are not sure.
Which structure is best? Although not exhaustive, we hope that this chart will give you an overview of the four most commonly-used structures and their pros and cons.
Note that some partnership agreements do allow annual changes in distribution of income or losses; check the wording of your agreement if you're not sure.
Check out our other articles which discuss these in more depth, such as
Feel free to contact our experienced team on 0800 890 132. Please see the desktop version of this website if the chart does not display on your mobile device. This page uses a script from SCRIBD to display the PDF.
Accounting for your rental residential investment property; specialised property tax advice. Buy me a coffee!