The potential advantages of tax-deferred income from ...

The potential advantages of tax-deferred income from property funds

Property funds typically make regular income distribution payments to investors. These distributions are primarily the result of rental income received from tenants in properties that are directly held by the funds. Part of these distribution payments may contain a `tax-deferred' component.

Tax-deferred distributions have the potential to provide a number of benefits to long-term investors, such as enabling the opportunity for a deferred tax liability and, therefore, enabling greater re-investment. For certain investors, tax-deferred distributions even have the potential to be wholly tax-free.

Key benefits of tax-deferred income ?? For long-term investors on capital account, income tax

may not be payable on the tax-deferred component of the distribution, provided the total tax-deferred components doesn't exceed an investor's cost base in the investment. ?? Tax-deferred distributions operate to reduce an investor's cost base in the units held and tax-deferred income is, in effect, only brought to account when an investment is sold. ?? Investors holding units in a property fund on capital account for more than 12 months will receive a 50 percent discount on capital gains (i.e. the difference between the sale proceeds and the cost base in the investment). ?? Superannuation funds receive a one third discount on capital gains if their investment is held for more than 12 months on capital account. ?? For superannuation funds in an allocated pension phase, capital gains may be tax-free. As such, gains realised on investments held from the period prior to the allocated pension phase may also be tax-free. Effectively, the result is that tax-deferred distributions can be tax-free.

What are tax-deferred distributions?

Tax-deferred distributions arise as a result of differences between the earnings of the fund and its taxable income. These differences can arise because of tax depreciation deductions available to the fund. Income tax may not be payable on tax-deferred amounts, however these amounts may operate to reduce an investor's cost base in their investment. As a result, the tax liability is deferred until a capital gain (if any) is realised.

10 Australian Unity Investments?Property Insights

Case study 1: Tom benefits from tax-deferred distributions

Tom wants to invest $50,000. Tom has a marginal tax rate of 46.5%, including a Medicare levy of 1.5%. He is considering two options.

At the end of three years Tom decides to dispose of the unlisted property trust investment. To keep things simple, let's assume there is no capital growth of the investment over the three-year period.

For the purposes of the example, it is assumed that both investments in unlisted property funds pay a distribution return of 8% p.a. The only difference is that one of the investments provides a tax-deferred component of 50% for its distributions. Further, to make calculations simpler, earnings are not re-invested.

1. Invest in an unlisted property fund that pays income distributions of 8%.

2. Invest in an unlisted property fund that pays income distributions of 8%, of which 50% of the distributions are tax-deferred.

Under the first investment option, in the first year Tom receives income of $4,000 ($50,000 x 8%). This amount is included in his taxable income. Based on his tax rate of 46.5%, Tom will pay tax on these earnings of $1,860 p.a., resulting in after tax earnings of $2,140. At the end of a three-year period, Tom will have total after-tax cash earnings of $6,420.

On disposal, the tax-deferred distributions in the second option will effectively be recouped via a capital gain, due to the taxdeferred distributions reducing Tom's cost base in the unlisted property trust investment. As such, he will have a capital gain of $6,000 (3 x tax-deferred income of $2,000). As Tom is holding the investment on capital account, he will be eligible for a 50% discounted capital gains, reducing his capital gain to $3,000. At his marginal tax rate, Tom will have a capital gains tax liability of $1,395.

Tom's three-year investment summary

Unlisted property Unlisted property

fund (no tax-deferred fund (with 50% tax-

component)

deferred component)

Income received

$12,000

$12,000

Income tax (46.5%)

$5,580

$2,790

Capital gains tax

Nil

$1,395

Total after-tax return

$6,420

$7,815

Under the second investment option, Tom will receive a distribution of $4,000 from the property fund, of which $2,000 is tax-deferred. Tom will pay tax on the earnings of $930 p.a., resulting in after-tax cash earnings of $3,070. Assuming he holds the investment, at the end of a three-year period Tom will have total after-tax cash earnings of $9,210.

In addition, Tom's capital gains tax liability may be lower if he disposes of the unlisted property fund investment in a year in which his marginal tax rate is lower, say, when he ceases full time employment. This could have the effect of further enhancing Tom's after-tax return.

The potential advantages for SMSFs moving to pension

For self-managed superannuation funds (SMSFs), the tax-deferred component of the income distributions from property funds can have additional potential benefits. This can be particularly evident if a SMSF holds an investment into allocated pension phase.

Because capital gains in allocated pension phase can be tax-free, the capital gains realised on investments held from the period prior to the allocated pension phase may also be tax-free.

Case study 2: Sarah's SMSF sees benefit from tax-deferred distributions

Sarah estimates she will retire in three years and is considering investing $50,000 through her SMSF into an unlisted property fund investment. Sarah's SMSF is a complying superannuation fund, has a 15% rate with a one-third discount for capital gains, and does not re-invest its after-tax earnings.

On retirement, Sarah's SMSF plans to move into an allocated pension phase and, as such, will have a tax rate of zero. The unlisted property fund investment would be sold when Sarah's SMSF is in allocated pension phase.

Sarah's SMSF three-year investment summary

Unlisted property fund (with 50% tax-deferred component)

Income received

$12,000

Income Tax (15%)

$900

Capital Gains Tax (0% for allocated pension phase)

Nil

Total after tax return

$11,100

Following the same analysis as Case study 1, Sarah's SMSF outcome is shown in the table opposite:

As Sarah's SMSF is in an allocated pension phase at the time of the disposal of the unlisted property fund investment, the taxdeferred distributions received over the life of the investment are effectively tax-free.

Important information: This article is general information only and should not be regarded as tax advice. Investors should seek their own independent tax advice, taking into account their particular circumstances, before investing.

Australian Unity Investments?Property Insights 11

Find out more information about our property funds Visit our website at .au for the latest performance information and updates on all of our investment products.

To find out more about our managed real estate investments, please contact your financial adviser or Business Development Manager.

Alternatively, you can contact us on the details below.

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Address Investor Services Adviser Services Website Email

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Important information

Australian Unity Funds Management Limited (ABN 60 071 497 115, AFS Licence No. 234454) is the issuer of the Australian Unity Healthcare Property Trust and the Australian Unity Office Property Fund. Australian Unity Property Limited (ABN 58 079 538 499, AFS Licence No. 234455) is the issuer of the Australian Unity Retail Property Fund, the Australian Unity Industrial Property Trust (closed to new applications), the Australian Unity Property Income Fund and the Australian Unity Geared Property Income Fund. Australian Unity Property Funds Management Limited (ABN 28 085 352 405, AFS Licence No. 233718) is the issuer of the Australian Unity Diversified Property Fund.

The Professional Planner | Zenith Fund Awards are determined using proprietary methodologies. Fund Awards and ratings are solely statements of opinion and do not represent recommendations to purchase, hold, or sell any securities or make any other investment decisions. Ratings are subject to change.

The information in this edition of Property Insights is general information only and does not take into account the financial objectives, situation or needs of any particular investor. Investment decisions should not be made on the basis of past performance. Before deciding whether to acquire, hold or dispose of a product, an investor should refer to the relevant Product Disclosure Statement (PDS). A copy of the PDS can be obtained by calling us on 1800 649 033 or 13 29 39 or visiting . au. The information provided here was current at the time of publication only. Past performance is not a reliable indicator of future performance.

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