Buying a property through a Self Managed Superannuation Fund
Investing in property though a self-managed super fund (SMSF) is a hot topic in the media and in discussions around the BBQ with friends.
SMSF’s are able to borrow and, just like you, can also borrow money in order to purchase a property. We’ve discussed how investing in property is an effective long-term investment in our recent article ‘How much does it REALLY cost to own a rental property and is it for ME?’, so the opportunity to use a SMSF to make this a reality has prompted many people to start a SMSF.
This is great, but you need to keep in mind that managing a SMSF is complicated and you really need to make sure you understand what you’re getting into. The following are two areas of property investments and things you need to know about them:
- Residential property
Property purchased through an SMSF cannot be lived in by you, any other trustee or anyone related. It also cannot be rented by you, any other trustee or anyone related to the trustees.
Further to this, your SMSF cannot purchase an existing residential property that you own personally, even if the SMSF purchases it for market value.
- Commercial property
Commercial property is different from residential property in that it can be purchased by a SMSF from its members, and it can be used by the members and related parties, providing this is done one an ‘arm’s length’ basis.
Many small business owners use their SMSF to purchase a business premises and then pay rent direct to the SMSF. It’s important to get this right; the rent paid must be at the market rate (no discounts) and must be paid promptly and in full at each due date.
The investment must also satisfy the sole purpose test which is to provide retirement benefits for its members.
Before you apply for a loan for your SMSF be aware …
… borrowing criteria for an SMSF is generally much stricter than for personal property loan. The loan also comes with higher costs, which need to be taken into account when working out if the investment is worthwhile.
Currently the general consensus is that most financial institutions will not consider lending to an SMSF unless they have a balance of at least $150,000 and, depending on the value of the property, often more.
The type of borrowing arrangement that is allowed for SMSF is what is called a ‘Limited Recourse Borrowing Arrangement’ (LRBA).
Repairing and improving a property
Where there is a LRBA in place the SMSF cannot borrow to improve the assets; it is, however, allowed to repair and maintain and property.
What is the difference? An Improvement is “significantly altering the state or function of the asset for the better”. Improvements would include extensions, adding pergolas, demolition and rebuilding.
If the SMSF can fund the improvements from its existing resources (i.e. bank account) then this is not borrowings and so is permitted.
The tax benefits of using a SMSF
SMSF’s receive concessional taxation treatment from the ATO which can have significant advantages.
The tax rate on SMSF’s is 15% tax on rental income from the property. On capital gains properties held for longer than 12 months, the fund receives a one third discount on any capital gain it makes upon sale, bringing any capital gains tax liability down to 10%.
If the property is purchased via a loan, the interest payments are tax deductible to the fund. If expenses exceed income there is a taxable loss that is carried forward each year and can be offset on future taxable income or tax on superannuation contributions.
The main benefit is that once trustees start receiving a pension at retirement, any rental income or capital gains arising in the fund – thanks to the property – will be tax free.
Things to remember
A SMSF has a lot of compliance issues that you need to keep in mind. Previously your superfund managed this, but it’s now yourresponsibility … hence: ‘Self Managed’.
All trustees are personally liable for any decisions made by the fund, even if they engage a third party to assist, or another member/trustee makes a decision. It is therefore really important to engage experienced, qualified specialists to assist you when taking on the role of managing your own retirement savings.
I would strongly recommend that you discuss your plans with your accountant, finance broker and bank prior to setting up the fund to ensure that you understand the obligations and costs that are associated with establishing a SMSF.