Should you invest in property using your SMSF?
What is a Self-Managed Superannuation Fund?
Self-Managed Superannuation Fund or SMSF is a private superannuation fund that you can manage yourself, as opposed to industry super funds that are managed by a superannuation provider. SMSFs can have between one and four members.
In 1992, when the compulsory employer contribution scheme was introduced under the Keating Labor Government, Australians were mandated to set aside money, in the form of contributions, to fund their retirement. The recent years have seen a growing number of Australians become more aggressive in planning for their future while at the same time taking direct control of their retirement savings by setting up SMSFs. The last five years alone have seen the number of SMSFs grow by some 31%. According to the Australian Taxation Office (ATO), SMSFs now make up 29% of the $2.1 trillion total superannuation pool.
Self-managing your superannuation allows you more involvement in what you invest in, as well as tax benefits that major industry providers do not. However, SMSFs require you to prepare and implement an investment strategy which you must visit regularly, and be solely responsible for. Simply put, choosing to have an SMSF investment strategy means you are in charge.
Can you use your Self-Managed Super Fund (SMSF) to buy property?
SMSFs can be used to buy investment properties. This growing trend has become increasingly popular among Australians in recent years. Buying property through SMSFs is a relatively stable and low risk investment compared to other options, and can offer considerable returns. More importantly, you are given more control over your property investment than you are with other options, and you can even gain access to significant tax efficiencies.
By using your self-managed fund, you can also make use of borrowed monies to purchase a single asset or a collection of identical assets with the same market value. The Limited Recourse Borrowing Arrangements (LRBA) is the specific method that involves SMSF trustees taking out a loan from a third-party lender. The trustee then makes use of the funds to purchase a single asset (or a collection of identical assets that are of the same market value) to be held in a separate trust. With an LRBA, if the loan defaults, the lender’s rights are limited only to the asset held in the separate trust. The whole super fund is not at risk.
It is important to know, however, that purchasing a property with an SMSF may not be for everyone. There are some key factors that will allow this investment strategy to be considered. And while there is no prescriptive formula to take, there are many different ways trustees can take to manage their fund and investment strategy.
If you use your SMSF to buy property, what sort of property should it be?
Property investments using your SMSF can either be in the form of residential properties (established houses and units, house-and-land packages, serviced apartments, and dual-key properties) or commercial properties (offices, retail spaces, factories). Both residential and commercial property options offer their own set of benefits and challenges. With a properly optimised loan structure, investing in property through your SMSF can provide you with great returns and some of the best tax incentives.
Residential purchase using an SMSF
The bottom line of investing in a residential property using SMSFs is that you, or any other trustee, or anyone related to the trustees, are not allowed to live in it. You can invest in a residential property but you can only rent it out to the market. Also, 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 as a contribution to its total amount within the cap limits.
- It should meet the ‘sole purpose test’ of solely providing retirement benefits to fund members
- It can’t be acquired from a related party of a member
- It can’t be lived in by a fund member or any fund members’ related parties
- It can’t be rented by a fund member or any fund members’ related parties
Planning to invest in residential property but not enough savings in your super? One thing you could consider is the Tenants In Common (TIC) agreement. This allows you to split the borrowing across your family home and your super fund.
Commercial purchase using an SMSF
People more commonly use their SMSF to purchase commercial property to lease back through their business. Generally, commercial properties offer more profitable rental returns than residential investments because of longer leases and higher yields.
Commercial properties can be sold to an SMSF by its members and can also be leased to SMSF trustees or an individual or business related to them.
However, there are still a list of considerations in holding commercial properties in an SMSF.
- The terms of the list should be commercially competitive. The ATO monitors and audits SMSFs regularly and makes sure that its members are given financial advantage in their investment.
- Many small business owners use their SMSF to purchase business premises and then pay rent directly to the SMSF. Even in an income downturn, the rent or payment must be made on time and in full.
- SMSF compliance relies on regular valuations being done on the commercial property. As SMSFs are self-managed, time and a lot of paperwork are to be expected.
- The investment itself must satisfy the “sole purpose” test which means that the sole purpose is to provide retirement benefit to the fund’s members.
What are the advantages?
There are significant advantages to owning property through the use of SMSFs. Many Australians have chosen this route to secure their retirement and build their wealth.
1. Income tax efficiencies
Any rental income from your property that is paid into your SMSF is usually taxed at 15%. This is considerably lower than the personal tax rate that can be charged at up to 49% if income is earned outside of the SMSF. Another plus side to this is that when you reach the preservation age and start drawing pension from your SMSF, the rental income from your property becomes tax-free.
2. Capital Gains Tax discount
Capital Gains Tax (CGT) is only charged when an asset is sold for a profit. In SMSFs, when an asset has been owned for at least 12 months, a discount of one-third is offered. The CGT rate payable may depend on whether your SMSF is in the accumulation stage (pre-retirement), or payout stage (once you have retired and are drawing down payments). Also, when you’ve started receiving a pension from your SMSF, you won’t have to pay CGT when you sell the property.
3. Property is a relatively stable and low risk investment option
Investing in property is a secure way to build your wealth. With the flexibility of an SMSF, trustees can purchase a property, pay for its repairs and maintenance, and capitalise interest. If done correctly, property can offer good income and capital growth over the long term. Investment in property also fluctuates less than in shares. And because you have full control of the fund’s property purchase, you also decide when to sell, and how to manage rent.
4. Diversification of super portfolio
Your investment property or properties are not recommended to be 100% of your super fund. A change in market conditions may require you to consider other investment options such as corporate bonds, shares, commercial real estate, and infrastructure. When you diversify your assets, you can strengthen your super fund and generate less risk. Always seek expert advice from a financial advisor when you are considering updating your investment strategy.
5. Assets Held In An SMSF Are Protected Against General Debt Recovery
In general, funds that are held within an SMSF are protected from creditors in the event of insolvency. When a trustee is declared bankrupt, they become classified as a disqualified person and therefore, will no longer be allowed to be a trustee of the SMSF. When this happens, the fund is given six months to restructure, and the trustee must transfer the superannuation interest out of the SMSF.
Sample case study for setting up your SMSF to purchase property
Samantha and Adam, a couple in Melbourne, had separate super accounts when they first approached us, which their respective employers had set up a long time ago.
Our financial planners assisted them to transfer both their super accounts and form one Self-Managed Super Account which had a combined amount of $456,000.00. We were then able to assist Samantha and Adam purchase a residential investment property using their super with a total purchase price of $482,000.
Our mortgage brokers were able to get them a 60% LVR loan which saw them retain over $235,000 of their original balance. The total loan within their self-managed super was $273,600 and the clients avoided a substantial amount of interest on the loan because we were also able to secure a 100% offset account allowing their remaining balance to offset the interest related to the loan.
This allowed the clients to make extra super contributions alongside the new rental income to pay this property down as aggressively as possible.
What are the disadvantages?
1. Property is not as liquid as shares
In setting up your SMSF investment, consider the liquidity of your SMSF’s assets. It is important to know how easily they can be converted to cash, their ability to pay benefits when members retire, and how they can cover expenses that may arise. As the trustee of the super fund, you need to consider whether it is appropriate for insurance to be held within the fund for each of the members as part of the regular review of your investment strategy.
2. Property type and usage restrictions
It is important to know that your SMSF property investments have certain restrictions on how they can be purchased or used. This means, your super fund cannot be used to buy yourself or your family member, residential property, including renting it out to persons related to the fund’s trustee. All investments all need to meet the “sole purpose” test.
3. Cost of purchasing, maintaining and selling an investment property
The truth is, while an investment property should be able to provide you with a regular income, there may be times that you won’t have a tenant. When you purchase a property, you must also be aware of the heavy fees such as stamp duty, and the amount of paperwork which will also be present upon selling the property. Most important thing to consider is that while property values rise, they may also fluctuate.
Maintaining the property over the lifetime of the investment will also be your responsibility and apart from the time and effort this would cost you, there will certainly be expenses as well which could eat up money in your super fund.
4. Borrowing conditions are stricter and can be costly
The SMSF fund generally needs to have a minimum balance of $120,000, and also, an annual contribution of at least $15,000. Most banks also require an SMSF to have at least 30% of the property’s value as a deposit. Higher interest rates are also often the case in these conditions.
Talk to a Financial Planner
A well-considered and carefully created investment strategy for your SMSF is integral if you decide to set up your SMSF. However, it does not necessarily mean that you will be doing everything on your own.
The best decision you could make is seeking professional and expert advice to help you manage your super fund. Financial advisors specialise in building your investment portfolio, and making your money work for you.
Leave your contact details to schedule a call with a financial planner to discuss your options.
Disclaimer: The information on this blog is for general information purposes only. It is not intended as legal, financial or investment advice and should not be construed or relied on as such. Visit our website for a full disclaimer and for licence details.