Buying property through an SMSF can be a rewarding investment strategy, but you’ll need to navigate these common mistakes to avoid rendering your fund non-compliant and landing in hot water.
Blogger: Justin Beeton, founder and managing director, The SMSF Club
Buying an investment property through a self-managed super fund (SMSF) is very different to buying the same property in your own name. There are special laws that need to be complied with, the banks’ lending requirements are different, there are more legal costs and the properties you have to choose from can also vary.
The main mistakes people make in this area include:
1. Property location
The location of your investment property impacts upon your potential rental returns, which are important in order to meet the loan repayments. It is very dangerous to purchase a property in an area reliant upon only one industry for its growth.
I have seen instances where people have acquired an investment property in a mining area in Western Australia, where the only industry was mining. There were three mines digging for iron ore and no other economic drivers. If the price of iron ore collapses or our exports to places like China drop off, so do the growth prospects of this town and finding tenants will become almost impossible. In these instances, the loan cannot be serviced and the property would need to be sold – probably at a loss.
More recently, we heard Holden’s announcement that it will be ceasing manufacturing operations in Australia in the next few years. This will have an obvious impact on those areas where Holden currently has manufacturing plants. So you need to carefully consider investing in an area reliant upon only one industry.
2. Incorrect legal structures
Incorrect legal structures are still being used by many people investing in property through an SMSF. If your SMSF will be borrowing money for the purchase, you will require a custodian/bare trust structure in place before contracts are signed.
The purchaser on the contract cannot be the trustee of the super fund if borrowings are involved. When using borrowings, you must comply strictly with the laws set out in the superannuation legislation, including the ‘single acquirable asset rule’.
In short, you need to ensure your super fund is acquiring one title only. There is an exception for strata title properties where the car park is on a separate title if specified conditions are included in the strata plan.
Therefore, you cannot turn up to an auction on a Saturday, successfully bid on a property and sign a contract in your personal name, with the intention of changing ownership to the bare trust structure later on. By buying a property at auction, you are entering into a legally binding contract then and there.
The correct procedure is to have the bare trust structure in place before the auction. If you do not yet have the structure in place, do not buy at auction.
Some investors also get caught out buying a property with other people they know, using a unit trust structure. The superannuation laws do allow for this type of structure if done correctly. There are two main variations: one in which borrowings are allowed and the other in which borrowings are prohibited. Basically, two or more people with their own SMSF come together and their SMSF buys units in a unit trust, which owns the property.
However, the Australian Taxation Office (ATO) has come across cases where this structure has been used in ways that are non-compliant. If this happens to you, the whole structure will have to be unwound and the property will be sold. Penalties may also be involved, which you would be liable for as the trustee of the fund.
3. Family planning failures
Investors who are involved with multiple-member SMSFs can get into strife if they don’t account for the impact divorce or death could have on the fund.
An SMSF can have up to four members. Therefore, mum and dad and one of their adult children and the child’s spouse could make up a fund. As could two couples who know each other and/or operate a business together.
If a member couple files for a divorce, then you need to be aware that superannuation benefits are an asset that can be split under Family Law Act property proceedings. If the investment property or business premises owned by the SMSF comprises most of the super fund assets, then it is likely the property will need to be sold. If the property has not been held for long, then a loss is most likely after taking into account stamp duty, legal costs and sales commission.
In a similar way, if one member dies unexpectedly, their share of the property is part of their death benefit, which has to be paid out to their beneficiaries. Again, the property may need to be sold.
Don't miss my next blog where I'll reveal three more massive mistakes investors make when purchasing property through their SMSF and detail how you can avoid making these costly mistakes.