In 2010, a change to the rules allowed a Self-Managed Super Fund (SMSF) to borrow money to invest in property assets. Before the rules changes, direct investment in property via super fund was rare because few had enough money in super to purchase a property outright.
Since the rules changed, more people are setting up their own SMSF, and more people with an SMSF are turning to the perceived safety of bricks and mortar. Whilst these rules make it easier to borrow in super, there are still some restrictions regarding purchasing a property with an SMSF. Setting up and administrating an SMSF can be complicated. So it is very important that you seek advice from a professional before you decide to take this route, and we are well experienced in this strategy so can assist you right through the process.
Why is it considered a good idea?
If you purchase an investment property outside your super, you will be required to pay a capital gains tax when you sell it to fund you retirement. Additionally, if you’re thinking about retiring on the rental income of such investments, you will pay tax at the full rate on that income even if you’re retired.
Holding the same property in a super fund could reduce the tax to zero if you sell it once you start drawing down a pension. Additionally, currently any rental income is only taxed at 15% and not taxed at all if you are drawing a pension. Buying an investment property through your super could also help you pay it off faster. All the rent and your super can go towards paying down the loan. You could also pay down your SMSF property by ‘salary sacrificing’ whilst you are working, giving you additional tax benefits. Additionally, maintenance and upkeep costs can also be tax deductible within your super.
What are the drawbacks?
You are not permitted to live in an investment property you purchase with your SMSF. However, you are allowed to use your SMSF to purchase business premises for your company.
Other restrictions include development of the investment property. Whilst you are allowed to maintain and refurbish the property, you are not allowed to develop it or change it in any significant way. This means that buying a property, developing it and turning it over for a quick profit is not an acceptable investment for a SMSF. You also can’t plan to profit by making a sub-division. Property investment under your SMSF is a medium to long term proposition.
A common strategy implemented by business clients is to acquire business real property (usually the premises from which their business is run) via their SMSF and then lease this property to a related party. This is typically a standard transaction, similar to that conducted with an arms length third party. However, complexity arises where the related-party tenant wished to make changes or improvements to the property. Invariably, on the exit of a commercial tenant a refurbishment is required, or economic changes may force a change in use and layout during a lease term. Acquiring real estate and then leasing same to a related-party tenant can be a worthwhile strategy for SMSFs. However, where a tenant fit-out is required, complexities can arise. To minimise any superannuation law compliance risk, it is imperative that the relevant paperwork is appropriately drafted from the outset.
It is also important to consider paying off any property investment within your SMSF before you stop working, otherwise the loan will have to be repaid from your super’s other investments and that could leave you short of a retirement income if you don’t plan correctly.
How do you go about borrowing for a SMSF?
There are rules about the type of loan you can use to purchase property through your SMSF. You are required to use a Limited Resource Borrowing Arrangement (LRBA) which means that the property itself is the security for the asset. No other assets either within or outside you super fund are allowed to be used as security for the loan. This provides a superior level of asset protection than owning the property outside your super.
Generally speaking, you can borrow 65-80% of the property value using your SMSF. So for a $400,000 property, your super fund would need to provide at least $80,000 in cash for a deposit plus stamp duty and legal fees. There is also the additional expense of setting up you SMSF, if you don’t already have one established.
Sometimes lenders will charge 2-4% more for an investment loan inside your super because of the complexity of the arrangement. However, we have access to experts at locating the right loan for your needs and can assist you right through the process.
Talk to the professionals
If you’re thinking about setting up your own SMSF to purchase property, or if you already have a SMSF and would like to invest, the legal intricacies are quiet complex and you will need expert advice to do it properly. Getting it wrong could incur harsh penalties and you could be taxed as much as 46.5% on your super’s assets if it is not set up and operated correctly.
If you are looking at leasing the property to a related party, involvement by a local legal practitioner with experience in superannuation and tax law is recommended and should highlight tips and traps associated with such a strategy.
But get it right and it could make the difference to your retirement income objectives! Contact us if you would like to discuss this strategy specifically to your circumstances.
Excerpt from our Summer Newsletter 2015
Disclaimer: Any information in this document is general only and does not take into account the objectives, financial situation or needs of any particular person and therefore is strictly not intended to be financial or taxation advice. You should obtain financial and taxation advice relevant to your specific circumstances. Whilst every care has been taken in the preparation of this information, SJW Accountants do not guarantee the accuracy or completeness of the information.