Invested in a property trust? Here is one advantage you may not know about

1. Assessable Components: These represent the taxable portion of the distribution, such as net rental income.

2. Non-Assessable Components: These are not subject to immediate income tax and occur when the trust’s cash distribution exceeds the assessable components of the distribution.

It is this second component where you will find tax-deferred amounts.

What are tax-deferred amounts?

Now that we've explained where property trusts make their money, we can discuss what tax-deferred amounts are.

Tax-deferred amounts are distributions from a trust that have been received by an investor but are not assessable for income tax purposes until a capital gains event occurs. In the next part, we'll explain what those capital gains events are.

Tax deferrals in the context of property trusts

Property trusts claim deductions for things like depreciation, interest, and construction costs. This creates a difference between the trust's distributable income (cash distributed to investors) and its net taxable income.

The portion of the distribution exceeding the net taxable income is considered a tax-deferred amount. You may be eligible as a unit holder to not pay tax on this amount immediately.

Instead, the tax-deferred amount gets deducted from your cost base for the investment. This means it lowers the amount you're considered to have paid for the units in the trust. This will stay the case until you either sell your units in the trust or the trust sells its assets.

So how does this benefit you?

When used strategically, tax-deferred amounts can offer several advantages for savvy investors:

• Reduce the tax you pay in the current year

• Depending on your investment timeframe and entity type, you might qualify for concessional discounts on capital gains, and

To explain this last part, let's go through two scenarios assuming an individual investor, eligible for the capital gains tax (CGT) discount:

Scenario A (Status Quo): You buy an investment for $100 and earn $10 in income this year. After you pay tax on that $10, and hold the investment for another 5 years, you sell for $110.

Scenario B: You buy an investment for $100 and earn $10 in income this year but the investment is 100% tax-deferred. You still hold the investment for another 5 years and then sell for $110.

In Scenario A, you pay tax at your marginal income tax level on the $10 profit this year. Then, when you sell in five years, you’ll either get the 50% capital gains discount on your $10 gain ($110-$100) and pay tax on only $5, or you may be able to offset the $10 gain against a $10 loss endured elsewhere and pay no tax.

At worst, you paid tax on $15 ($10 in year 1, $5 when you sell), while at best, you pay tax on $10 ($10 in year 1, and nothing when you sell because you offset the gain against a loss).

In Scenario B, you pay no tax on your $10 income this year. However, your cost base was reduced to $90. When you sell in 5 years, you’ll have to declare a $20 capital gain ($110-$90).

As an individual eligible for a CGT discount, you may receive a 50% capital gains tax discount on the $20 gain, or you may be able to offset the $20 gain against a loss and pay no tax.

At worst, you paid tax on $10 ($0 in year 1, $10 when you sell), at best you pay zero tax because you offset the gain against a loss.

So why is Scenario B better than Scenario A?

1. The worst-case scenarios and best-case outcomes are numerically superior under Scenario B

2. All else equal, cash now is considered superior to cash later, and because of the lower initial tax liability under scenario B, it is the same as having extra money now, and deferring the tax liability to later.

Trilogy's approach to tax deferrals

After the end of every financial year, the Trilogy team provides its investors with appropriate documentation to assist them in preparing their annual income tax returns.

If applicable, these tax statements will disclose the ‘assessable’ and ‘non-assessable’ components of your distributions. As always, go through these carefully with your financial adviser and an accountant.

To learn more about industrial property, watch our episodes of The Pitch here:

Property

The return potential in this asset class is beginning to ramp up

View

Property

The asset class growing like a mushroom in our own backyard (and how to access it)

View

Find out more about Trilogy Funds here.