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By Dave McPhedran
One of the least understood aspects of Family Trusts is what a gifting program is really all about. I often hear people exclaim that they are ‘gifting off the house’ for example. and cringe. This statement alone demonstrates a lack of understanding of Trust fundamentals, which is often perpetuated to the unsuspecting audience of the moment.
When you sell any asset to a Trust, the Trustees must purchase that asset in their own joint names at current market value. The evidence of the valuation is extremely important and remains on file for the lifetime of the Trust. The Trustees, however, do not normally possess the funds required and purchase the asset with a loan made by the seller. This is in the form of a Deed of Acknowledgement of Debt, in which the purchaser borrows the funds required from the seller on the basis that the loan is unsecured, interest free and repayable on demand. These are not onerous terms as the seller is almost always the person who set the Trust up in the first place.
At this point title changes hands, the Trustees now fully own the asset but also owe the total value to the seller. The seller, on the other hand, no longer owns the asset, but in turn owns a loan of equivalent value. This to most of us is an unusual concept as we normally owe, rather own loans. When we own a loan therefore it is a tangible asset which must be included in any official declaration of assets.
So why is this all so apparently complicated? Well the essential problem is that you can’t just give away your assets to family & friends to prevent them falling into someone else’s hands in hard times. This is where the Gift Duty Act comes in, which restricts the amount you can freely give away to $27,000 per year.
If we were therefore to tell the Trustees that they were able to reduce the balance of the loan owed to us, it is the same as making a ‘gift’ to the Trust. As the idea of the Trust in the first place was to have the Trust own all our major assets, this can also be viewed as a gradual transfer ($27,000 pa) of our major asset (an unsecured loan) to the Trust.
If all your major assets were owned by a Trust, you would inevitably be in a gifting ‘program’. This means that you own a debt which you are forgiving on a regular basis at the rate of $27,000 per year until it disappears. At any given time the net worth of your major assets outside the Trust would be the balance of this loan.
So the point is you are not ‘gifting off the house’, but rather ‘gifting off the loan’. And this is not just a matter of semantics. If for example a couple sold their family home to their Trust for $540,000 they would need 10 years to fully gift off the resulting unsecured loan. If after 5 years they had made $270,000 of gifts (5 @ $27,000 each) and then were forced to declare their assets, say in the case of bankruptcy, they would have to include the outstanding balance of the loan $270,000 plus a ‘clawback’ of possibly up to 2 year’s gifting which would adjust the balance to $378,000.This debt is now enforceable and the Trustees can be made to pay up. This does not however necessarily mean the inevitable sale of the house. In 5 years the house may have increased substantially in value, lets say 40% and is now worth $756,000.
As the creditors can only get access to the adjusted balance of the unsecured loan ($378,000) the Trustees should be able to comfortably use the extra equity in the house which is fully owned by the Trust to finance the repayment.
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