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Buying property through an SMSF can be a rewarding investment strategy, but you’ll need to navigate these common mistakes in order to avoid rendering your fund non-compliant and landing yourself in hot water.
Blogger: Justin Beeton, founder and managing director, The SMSF Club
In my previous blog, I detailed three key mistakes investors make when using their SMSF to buy property. Here I reveal three more errors they make - and how you can avoid them.
4. Insurance issues
Not having the property correctly insured is another mistake. You should ensure you have replacement insurance for fire damage to the property, so it can be replaced. In addition, you must have public liability insurance in case a tenant or a tenant’s guest suffers an accident leading to significant injuries resulting in large damages action.
If this were to occur without proper insurance then not only would your SMSF lose the property but all the other assets of your super fund would be at risk as well. This could have horrendous implications for the members’ retirement plans.
In addition, each member should consider life insurance cover to pay off the debt on the property so the surviving member has the option to retain the property upon the death of their spouse in a typical ‘husband and wife’ SMSF.
However, this option will only be possible if the insurance premiums paid from the SMSF are being correctly accounted for and paid from the correct member account balance or a reserve account of the SMSF.
5. Legal oversights
Having an enduring power of attorney in place for each SMSF member is crucial and an area in which some investors fall down if they don’t use an experienced solicitor to set up their SMSF.
Under the superannuation laws, every member of an SMSF must also be a trustee of the fund or a director of the corporate trustee of the fund. If you have lost mental capacity, you cannot be a trustee or director and as such, your SMSF would become a non-complying fund.
Your options in this situation are to either pay out the account balance of the member who has lost capacity, or wind up the fund. Again, if the property was only recently purchased, there will most likely be a loss in these circumstances.
6. Insufficient diversification
Investors should avoid having all of their SMSF’s assets in just one leveraged investment property or having only one asset class (such as property) comprising virtually all of the fund’s assets. A trustee is required by the superannuation laws to prepare an investment strategy and then invest according to that strategy.
A fundamental principle of investment theory and portfolio construction theory is asset diversification. In other words ‘Do not put all your eggs in one basket’.
This is one area that the regulators will be looking at in any review of an SMSF and its compliance with the law.
If you, as the trustee of your SMSF, are not familiar with how to put in place a proper investment strategy, then professional advice should be obtained in this area.
Another reason for diversification is for liquidity purposes. Assets such as shares can be sold immediately, whereas property can take some months to sell. There may be instances where cash is required urgently by your SMSF, so by investing in a range of assets including very liquid assets such as shares, cash can be available at short notice.
Avoiding costly mistakes
There are a number of mistakes that many people make when purchasing property through their SMSF. It is a complex area requiring advice from properly qualified professionals. The laws surrounding SMSFs are also multifaceted, so your regular conveyancing solicitor may not be up to date with all the legal requirements of the superannuation laws.
In addition, advice should also be sought from properly qualified advisers on how to mitigate your insurance risks.
Buying property through your SMSF is a great investment opportunity but you must do it properly, remaining compliant with all the laws – especially where borrowings are used.