Tax treatment of provider of capitalised interest loan

If a family trust makes and loan to another party, and the terms of the loan are such that no repayments are required until a future date, and interest is capitalised and added to the principle balance (ie like a reverse mortgage), what is the taxable income of the Trust when the loan balance is finally paid out? Is the original loaned amount subtracted from the loan balance and the remainder (being accumulated interest) is treated as taxable income for the trust?

Or is the trust "deemed" to have received interest income every year that the loan is in place and taxed on it each year (even though no actual repayments have been made?)

If it is a commercial loan, likely the trust is deemed to derive income on an acruals basis.

Similarly the borrower can only deduct on this basis if the loan is for a taxable purpose..

If you are playing funny games with the outstanding interest no compunding, the ATO could argue that it is a non-commercial loan, or that there is some debt forgiveness.

You will need to get some advice on whether this applies.

Cheers,

Rob

thanks Rob

Taxed on an accrual basis? - ouch! Well that kills off that option!

I am trying to work out the best option for providing re-financing for my wife's parents so they can stay in their home - I would be very grateful if you could take a look at my other post on this subject a couple of days ago and let me know which option you think is best from a tax perspective.

thanks and regards
Scott

Are you hoping to claim interest deductions for the trust ? This needs to be commercial.

Are you hoping to claim costs of depreciation on the property ? This requires the trustee to be the "holder".

A reverse mortgage usually involves the purchaser acquiring the property by instalments of capital which provides the income stream to the vendor (your parents), while property passes at some later date. i.e. the trust is purchasing, but if there is no income derived by the trust from the property then interest expense is most likely capitalised.

Not too sure how Centrelink would treat this for the assets test because the income stream has been "purchased", or whether it is just an income test. I try to stay clear of Centrelink ... they are too complex and too hard to deal with.

Sorry ...

Cheers,

Rob

Rob
Not trying to do anything funny/dodgy - just want to help the inlaws! Not looking to claim interest in the trust....

Per my other post, my wife's parents need to find an alternative source of finance so they can stay in their home. They received a loan of $150k from another family member to help buy the house and he needs the money returned now. We have the $150k cash (without borrowing) in our family trust we can use and definitely want to help..

Options I am looking at are:

1) a reverse mortgage where the in laws remain the title holders and our family trust is the financier of a $150k loan to the in-laws- but from what you have said this would mean the trust would need to be paying tax on interest charged on an accrual basis - if true I think I can discount this option.
2) Trust buys the house from them for the market value ($300k) then immediately sells them an enduring right to live in the house for the remainder of their lives for a consideration of $150k (Centrelink calls this a "Granny flat arrangement" and they have advised that this will not effect their pension eligibility.
3) The Trust gifts $150k to them, and they amend their wills to leave their home to us/our Trust.

Obviously each option has a different risk profile, but from the perspective of the Trust's tax position, which would be the best option?

I assume the answer is option 3) as under current laws no taxes/death duties would be payable on the house if left in a will? The main risk with this I imagine would be that the will is either changed or contested.

your thoughts?

Scott,
I answered your other stream first, so will only touch on a couple of points here.
A true reverse mortgage is only a first mortgage, just like any other first mortgage except that there are no requirements for principal or interest repayments during the life of the loan. Interest capitalises.

There is no transfer of ownership, it is just a mortgage. The funds can be advanced by way of lump sums, one or more, or a 'income' stream. The reverse mortgage itself has no pension implications, the use of funds may.

The answer to the trusts best option will depend on the level of gearing and opportunity cost. My preference would be ownership 100% and rent the property to the parents. You set up auto debits and the money is in the trusts account each month (or fortnight). I suggest you do the numbers to see the best option for the parents but if the $150k net is then their only financial asset, it will not trigger the asset test if they sold the home and it will most likely have a positive benefit as the rent assistance may be more then the effect of the deeming rates on the income test (if any).
Greg

Sorry ... assumed tax considerations were a major driver.

Are your wife's parents in a class of potential income or capital beneficiaries of your family trust according to your trust deed ?

Be mindful of any Family Trust Election, and any corporate beneficiaries with unpaid present entitlements.

If so, the possibility may exist to loan them the $150k, secured by a first mortgage over their house (or at least some sort of caveat) for security. That way, any non-commercial loan terms won't make the loan statute barred, whilst making low and/or deferred interest terms seem like pure family arrangements and so not assessable income to the trust.

Just think of it this way, if that $150k had been invested then you would otherwise have been assessed and taxed as a beneficiary for the income, and then gifted it to your parents-in-law without any deduction !!

Also, if they are in a class of income beneficiaries then you could stream some income to them at their low tax rates as some assistance.

Remember that Centrelink will be interested in them being beneficiaries so make sure they have no control of the trust.

Of course the trust could loan you (as a capital/income beneficiary) the $150k and you could on-lend (with security), all within family arrangements and so most likely no tax considerations (provided you don't make a capital gain out of the loan !!).

Note these ideas cannot possibly address your precise personal/family asset protection strategies, estate planning and tax situations based on such brief facts. They are just another approach.

Cheers,

Rob

I don't understand what you mean here Rob. Are you saying that if the loan is made on deferred interest terms that it is considered "non-commercial" and therefore the trust would not need to declare income associated with the accrued/deferred interest until the future repayment date?

I thought you were suggesting in your initial reponse that where interest is capitalised/deferred the trust would be deemed to be deriving income on an accrual basis each year and therefore subject to tax (even thoug no interest cash income is actually received)?

For a loan on commercial terms, interest would be income to the lender and would be deemed to be derived even when deferred.

Wholly non-commercial loans, such as loans to family members on non-commercial terms, do not derive income ... therefore timing is irrelevant.

This could be deemed a purely family arrangement and the loan regarded as a personal use asset of the lender.

The danger here is if the borrower defaults or the loan becomes statute barred, because then your capital losses are disregarded on personal use assets !!!

Cheers,

Rob

Maybe a capital loss is not ignored if the borrower defaults because this might give rise to a right to pursue them in court.

However, loan fogiveness or loans which become statute barred can be a problem.

Cheers,

Rob