Trusts are one of those financial tools that are somewhat shrouded in mystery for many people. They are often dismissed as complicated, expensive, or reserved for the wealthy elite, and assumptions like these frequently prevent the average person from exploring the benefits a trust can provide.
This is according to Calum Wedge, Financial Director at the Rawson Property Group, who says trusts can be an excellent financial tool or conduit for people of all types and income levels.
He says they are easy and inexpensive to set up, and when they’re properly administered, they can be an effective and affordable way to protect, preserve and distribute income generated by a variety of asset types, including property.
According to Wedge, one of the major benefits of buying property via a trust is separation of ownership. He says a trust is considered a legal entity, not a legal persona or juristic person per se, and is best described as a legal relationship created by a founder by placing assets under control of trustees.
Wedge says this means any asset owned by the trust, assuming it was bought responsibly and signed off by an authorised trustee, no longer forms part of an individual’s personal portfolio, and can’t be attached by personal creditors or executors of their estate.
This is particularly valuable for business owners who want to protect their personal assets should their businesses go under, he says.
In addition to protecting assets and mitigating personal risk, separation of ownership also means any property held by a trust will not form part of your estate when you die. This can dramatically decrease the amount of estate duty to be paid.
“A trust is immortal, so your beneficiaries will also continue to benefit from its assets after your death, with no need to pay transfer duties or Capital Gains Tax (GCT) on any properties it holds. It also eliminates any complications associated with having multiple heirs.”
One of the frequently cited downsides of holding property in a trust, is that Capital Gains Tax comes into play should you decide to sell. That said, it is certainly much higher on trusts than on individuals, with an effective rate of 27.31%, compared to a maximum individual effective rate of 13.65%, excluding any annual exclusions.
Wedge says the best way to minimise CGT when disposing of a property in a trust, is to apply the conduit principle and distribute said capital gain to multiple beneficiaries, while retaining the nature of the income.
Each receiving beneficiary will enjoy the R30 000 annual exclusion at their assumed lower marginal tax rate, resulting in substantial CGT savings. If that’s not possible, the additional CGT may be worth it for the security of protecting your home or investment. It all depends on your circumstances, and your trustees and trust administrator should be able to advise you accordingly, he says.
Income Tax is also commonly considered a disadvantage of a trust, charged at a fixed rate of 41% from the first rand. According to Wedge, however, there is a simple way to minimise the effect this has on profits.
“Income generated by a trust, such as rental income from an investment property, can either be taxed in the hands of the trust, at 41%, or it can be distributed to the beneficiaries pre-tax.”
In the event of the latter, he says that income doesn’t lose its identity and is included in the beneficiary’s personal taxable income, and is subject to their personal income tax rate.
A more serious disadvantage for trusts, especially when it comes to buying property, is the fact that finance can be difficult to come by, and 100% mortgages are almost unheard of.
Wedge says trusts are considered high risk by banks, at least partially because things are a lot more complex to resolve in the event of a default. “It is standard practice for trustees, excluding independent trustees, to have to stand surety for any loans granted, and sizeable deposits are often required.”
Nonetheless, Wedge says he remains positive about the current value of trusts as flexible vehicles for protecting one’s assets, property or not, against the inevitable uncertainties of life. The longevity of the current situation, however, is a matter of some debate.
“SARS has intimated that they are very likely to clamp down hard on trusts soon, possibly because they, like so many people, assume that trusts are solely a tool for the wealthy,” he says.
“Depending on how high the new taxes go, the value to expense ratio of trusts in South Africa at the moment may, unfortunately, become a thing of the past.”