Investing in property for your SMSF
Investing in property though a self-managed super fund has grown in popularity in recent years, particularly since it became possible for SMSFs to borrow money to fund their property purchase.
What with lots of spruikers selling supposedly foolproof property schemes, and plenty of opportunities for the unwary to get into trouble, this is an area where you really do need to make sure you know what you’re getting into. Here is our list of do’s and don’ts for investing in property through your SMSF:
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- The property must meet the ‘sole purpose test’ of solely providing retirement benefits to fund members.
- 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 into the super fund will cover these costs and allow for growth. Many people assume that if they contribute personal monies 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You may contribute your own money to help purchase the property, but that will be counted as contributions and can’t be withdrawn until you meet preservation age and a condition of release (for example, retirement).
The costs include:
- Upfront fees
- Legal fees
- Advice fees
- Stamp duty
- Ongoing property management fees
- Bank fees
- Property purchased through an SMSF cannot be lived in by you, any other trustees 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 isn’t allowed!
- The property also must not be acquired from a related party of a member, even at market value.
- One of the most popular ways to invest in property is through commercial property.
- Many small business owners get their SMSF to purchase their 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 overarching function of the SMSF which is to provide a retirement fund for the members. Getting the SMSF to purchase the building might make sense for your business, but does the building represent a good investment for the SMSF? Consider the yield and the expected growth in value, and if the property doesn’t shape up, you may need to reconsider.
And the tax consequences?
- If you buy a property through an SMSF, the fund will pay 15 per cent tax on the 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 CGT liability down to 10 per cent.
- If the property is purchased via a loan, the interest payments on the mortgage are tax deductible to the super fund. If expenses exceed income, there is a taxable loss that is carried forward each year and can be offset against future taxable income.
- Once fund members 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 rental, any tax losses cannot be offset against your personal taxable income outside the fund.
Borrowing to purchase property in your SMSF
Borrowing to buy property through an SMSF is achieved by way of a limited recourse loan. This means that the borrowing is made through a trust (often called a bare trust), which has the legal title in the property. Beneficial ownership rests with the SMSF, which then collects all of the rental income on the property. The reason for this arrangement is so that the lender can take charge of the property if the SMSF fails to keep up with the loan.
So in addition to the establishment of an SMSF and its trustee, an additional trust (bare trust) and trustee (which cannot be the same as that of the SMSF) must be legally established to enable the super fund to borrow and purchase the property.
Borrowing criteria for an SMSF are generally much stricter than for a normal property loan that you might take out as an individual and come with higher costs, which need to be taken into account when working out if the investment is worthwhile. It is strongly recommended that you approach a financial institution prior to incurring the costs of establishing an SMSF and the other legal entities required to get an idea of how much they are willing to lend you based on your current super monies and anything you may be willing to contribute personally to the investment.
Remember that loan repayments must be made from your SMSF, which means your fund must always have sufficient liquidity or cash flow 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.
Mark Chapman is the director of tax communications at H&R Block.
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