Investing in property through a self-managed super fund (SMSF) has grown in popularity in recent years, particularly since it became possible for SMSFs to borrow money to fund a direct property purchase.
This is an area where you really do need to make sure you know what you’re getting into. Here is our guide to buying property through your SMSF.
INVESTING IN RESIDENTIAL PROPERTY
Property purchased through an SMSF cannot be lived in by you, any other trustee or anyone related to the trustees – no matter how distant the relationship.
It also cannot be rented by you, any other trustee or anyone related to the trustees. So, buying a holiday home in your SMSF and living there during the summer is not allowed.
Further to this, you cannot put an existing residential investment property you have into an SMSF – either by way of the fund purchasing it at market value, or contributing it within the cap limits.
INVESTING IN COMMERCIAL PROPERTY
One of the most popular ways to invest in property through an SMSF is to buy commercial property. ‘Business Real Property’ can be purchased by an SMSF from its members, and it can be used by the members and related parties, providing this is done on an arm’s length basis.
Many small business owners use their SMSF to purchase a business premise 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 overarching function of the SMSF which is to provide retirement benefits for its members (this concept is known as the sole purpose test).
Using your SMSF to purchase a business premise may make sense for your business. However, to comply with the regulations, you must ensure the purchase provides a retirement benefit for the trustees.
Consider the yield and expected growth in property value. If the property doesn’t shape up, you may need to reconsider.
THE TAX CONSEQUENCES OF BUYING AND RENTING PROPERTY
If you buy a property through an SMSF, the fund is required to pay 15% tax on rental income from the property. On 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 by future taxable income.
Once trustees start receiving a pension at retirement, any rental income or capital gains arising in the fund will be tax-free.
Note also, that if you make a loss on your property, any tax losses cannot be offset against your personal taxable income outside the fund.
BORROWING TO BUY PROPERTY IN YOUR SMSF
Borrowing to buy property through an SMSF is achieved through a limited recourse borrowing arrangement (LRBA).
To ‘limit the recourse’ of the lender, a separate property trust and trustee is established to hold the property on behalf of the super fund, outside the actual SMSF structure. All the income and expenses of the property go to the super fund’s bank account. The super fund must meet all loan repayments. If the super fund fails to do this, the lender only has the property held in the separate trust as recourse, and cannot access the remaining assets of the super fund (if any).
BORROWING CRITERIA FOR SMSFS
Borrowing criteria for an SMSF are generally much stricter than a normal property loan which you might take out as an individual. The loan also comes with higher costs, which need to be factored 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 $200,000.
If your primary purpose for wanting to have an SMSF is to purchase property with a mortgage then consulting with a bank or mortgage broker is strongly recommended before you even establish the super fund, to identify if you have significant monies in super to obtain finance.
Remember that loan repayments must be made from your SMSF. This means your SMSF must always have funds available to meet the loan repayments. The SMSF can fund the loan repayments through rental income on the property and through superannuation contributions into the fund.
YOU ARE RESPONSIBLE FOR COMPLIANCE
The ability to purchase property in your SMSF with borrowings comes with some very strict rules and obligations that you may not be familiar with as they are not requirements that exist outside an SMSF.
Trustees are commonly found breaching these rules, as trustees are not aware of the rules until their fund is audited.
It is up to you as a trustee to make yourself familiar with what you can and can’t do as the ATO will hold you responsible.
There can often be expensive repercussions for not quite getting it right – from trustee penalties issued by the ATO to stamp duty implications.
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.
PURCHASE THE PROPERTY IN THE CORRECT NAME
The property must be purchased and held in the name of the trustee of the bare trust. From the signing of the contract to the name on the certificate of title. Many people purchase the property and then set up their SMSF and associated legal entities to arrange finance for settlement of the property. Failure to purchase the property in the correct name may lead to expensive stamp duty implications.
RENOVATING YOUR PROPERTY
Simple insignificant repairs and maintenance to the property can be paid for from borrowed monies. If you wish to do significant improvements or renovations to the property, this is allowed but must be funded by available cash already held within the super fund and not by the loan or borrowed money.
You are not allowed to make significant changes to the original asset that was purchased using the limited recourse borrowing arrangement. Renovations that substantially change the asset will require a new limited recourse borrowing arrangement.
SINGLE ACQUIRABLE ASSET
The concept of ‘a single acquirable asset’ is very important when dealing with a limited recourse borrowing arrangement (LRBA). The basic premise is, if the property runs over multiple titles, each title will require its own bare trust, trustee, and LRBA.
The ATO has clarified certain scenarios that it is permissible to have just one LRBA, and where multiple LRBAs would be required.
Single LRBA required in these scenarios:
- factory complex that runs over multiple titles and therefore cannot separately sell titles
- house and land package
- completed ‘off the plan’ property – if cash paid for the deposit, an LRBA can be used to pay the balance
- apartment with separate car parking space – although separate titles you can’t sell one without other, so one LRBA is ok
- option to purchase a house (just the option) -if the house is then purchased, this must be done with a separate arrangement as a different asset to the option.
Multiple LRBAs required in these scenarios:
- if the vendor will only sell the two titles together (but it is legally permissible to sell them separately)
- farmland with multiple titles-if no legal impediment to selling them separately
- a block of land purchased – at a later date it is decided a house is to be built on the block
- a serviced apartment that is fully furnished – the apartment and furniture are seen as two separate assets.
FEES AND CHARGES WHEN PURCHASING PROPERTY
There can be substantial fees and charges associated with the purchase, ownership and subsequent sale of a property in an SMSF. These will eat into your super balance so you need to ensure the income in the super fund will cover these costs and allow for growth.
Many people assume that if they contribute personal money into the purchase, that once the super fund has the money, they can repay themselves. This is not the case. You may contribute your own money to help purchase the property, but this is considered a personal contribution to your super fund and cannot be withdrawn until you meet preservation age.
This content has been prepared by Southern Business Solutions, ABN 62 550 042 926. The information is general in nature and does not take into account your personal situation. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice. Although every effort has been made to verify the accuracy of the information contained above, Southern Business Solutions, its officers, employees and agents disclaim all liability (except for any liability which by law cannot be excluded), for any error, inaccuracy in, or omission from the information contained on this website or any loss or damage suffered by any person directly or indirectly through relying on this information.
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