Using Super to Buy Property

How can using Super to Buy Property help you?

As the surge in self-managed super funds (SMSFs) continues in Australia, so too does the expected increase in residential property investments and yields to help save for your retirement. A change in rules a few years ago opened the door for investing through super after it allowed DIY (Do-it-Yourself) funds to borrow money for property assets. According to the latest government data there are now 439,000 self-managed funds holding $421 billion, or about one-third of the total superannuation savings pool.

But given the average super fund balance in Australia is still less than $50,000, until recently there was no chance of investing in property without having to borrow. Direct investment in property has traditionally been restricted to those with really big bucks in super or those borrowing to invest outside of super. But buying property inside super is proving a big drawcard, mainly because of the potential tax benefits.

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As a general guide (that is not classed as financial advice, as you should seek professional advice on such matters) you need a minimum of $250,000 in existing super savings for an SMSF to be a cost-effective option. Large SMSFs perform better than small SMSFs because they are more diversified, operate more effectively and have longer experience in the sector.
A minimum of $250,000 ensures you will have enough money to allow some diversification in your investments. Putting all your super investment into the one property basket, rather than spreading a portfolio across other types of investment, can be a risky strategy. Remember, this recommended fund size is based on the entire fund balance, which includes the superannuation assets of all fund members (e.g. your spouse).
Banks will generally allow SMSFs to borrow around 70-80 per cent of the property value, however it is more desirable to have at least a 50 per cent deposit so the property is positively geared or close to it. Tax-deductible personal super contributions, salary sacrifice contributions, and compulsory super guarantee payments made into your SMSF, as well as any rent your fund receives on the property, can all be used by your SMSF to help cover the loan repayments. It’s also important to have a sound strategy in place to pay the property off over time.
As an example only – If you buy a property through an SMSF, the fund will pay a maximum 15 per cent tax on rent it receives 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 capital gains tax liability down to a maximum of 10 per cent*.
Once fund members start receiving a pension at retirement – assuming they have held the property in the fund for this long, the fund will no longer pay tax on either rental income or capital gains when the property is sold.
Purchasing property through an SMSF is not advisable for people who don’t have a large enough lump sum to allow diversification of their investments. Ideally you would allocate a percentage to other investments such as shares and/or term deposits.
And, borrowing through an SMSF may not be a good idea for low-income earners who are really going to stretch themselves in terms of cash flow.
With great power comes great responsibility and there is no doubt that managing an SMSF successfully requires a lot of expertise, time and money.
It can cost around $1500 to $2000 or more to set up an SMSF (dependant on the complexity on your fund/s), but there are also adviser fees, accountant fees and ongoing annual costs to consider.
Further, there are rigorous auditing and reporting requirements for an SMSF and the ATO can impose harsh penalties for those who do not comply, so it is vital you get appropriate tax, legal and financial advice.
If you are considering buying a property through an SMSF, the first step should be to speak to a financial adviser about whether this strategy would suit your investment goals, timeframe and feelings about risk.
Buying property through an SMSF can be a powerful way for business owners to build their superannuation, ensuring you will be able to live the life you want in retirement. However, it’s important to be clear about your obligations and have the time, money and ability to meet them.
1. SMSF Statistical Report – June 2016, published by the Australian Taxation Office.
2. The Government has announced that, from 1 July 2014, the amount of exempt current pension income available to superannuation funds will be limited to $100,000 a year for each individual. Should this measure become law, fund earnings, derived from pension assets, above this limit will be taxed at the 15 per cent rate that applies to earnings in the accumulation phase. This measure is not yet law.
Property purchased through an SMSF cannot be lived in by you, any other trustee 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 is not allowed.
Further to this, 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 contributing it within the cap limits.
One of the most popular ways to invest in property through an SMSF is to buy commercial property. ‘Business Real Property’ can be purchased by an SMSF from its members, and it can be used by the members and related parties, providing this is done one an arm’s length basis.
Many small business owners use their SMSF to purchase a 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 retirement benefits for its members (this concept is known as the sole purpose test).
Using your SMSF to purchase a business premises may make sense for your business. However, to comply with the regulations, you must ensure the purchase provides a retirement benefit for the trustees.
Consider the yield and expected growth in property value. If the property doesn’t shape up, you may need to reconsider.
As an example – If you buy a property through an SMSF, the fund is required to pay 15% tax on 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 capital gains tax liability down to 10%.
If the property is purchased via a loan, the interest payments are tax deductible to the fund. If expenses exceed income there is a taxable loss that is carried forward each year and can be offset on future taxable income.
Once trustees 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, any tax losses cannot be offset against your personal taxable income outside the fund.
Borrowing to buy property through an SMSF is achieved through a limited recourse borrowing arrangement (LRBA).
To ‘limit the recourse’ of the lender, a separate property trust and trustee is established to hold the property on behalf of the super fund, outside the actual SMSF structure. All the income and expenses of the property go through the super fund’s bank account. The super fund must meet all loan repayments. If the super fund fails to do this, the lender only has the property held in the separate trust as recourse, and cannot access the remaining assets of the super fund (if any).
Borrowing criteria for an SMSF is generally much stricter than a normal property loan which you might take out as an individual. The loan also comes with higher costs, which need to be factored into account when working out if the investment is worthwhile.
Currently the general consensus is that most financial institutions will not consider lending to an SMSF unless they have a balance of at least $200,000 to $250,000 AUD.
If your primary purpose for wanting to have an SMSF is to purchase property with a mortgage then consulting with a bank or mortgage broker is strongly recommended before you even establish the super fund, to identify if you have significant monies in super to obtain finance.
Remember that loan repayments must be made from your SMSF. This means your SMSF must always have funds available 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.
It is important to be aware of that the ability to purchase property in your SMSF with borrowings comes with some very strict rules and obligations that you may not be familiar with as they are not requirements that exist outside an SMSF.  It is very common for trustees to inadvertently breach these rules, as trustees are not aware of the rules until their fund is audited.
It is up to you as a trustee to make yourself familiar with what you can and can’t do as the ATO will hold you responsible.
There can often be expensive repercussions for not quite getting it right – from trustee penalties issued by the ATO to stamp duty implications.
All trustees are personally liable for any decisions made by the fund, even if they engage a third party to assist, or another member/trustee makes a decision. It is therefore really important to engage experienced, qualified specialists to assist you when taking on the role of managing your own retirement savings.
Purchasing property under and SMSF arrangement, the property must be purchased, and held in the name of the trustee of the bare trust. From the signing of the contract to the name on the certificate of title. Many people purchase the property and then set up their SMSF and associated legal entities to arrange finance for settlement of the property. Failure to purchase the property in the correct name may lead to expensive stamp duty implications.
When renovating your property simple insignificant repairs and maintenance to the property can be paid for from borrowed monies. If you wish to do significant improvements or renovations to the property, this is allowed but must be funded by available cash already held within the super fund and not by the loan or borrowed money.
You are not allowed to make significant changes to the original asset that was purchased using the limited recourse borrowing arrangement. Renovations that substantially change the asset will require a new limited recourse borrowing arrangement.
Under the SMSF regulations – the concept of ‘a single acquirable asset’ is very important when dealing with a limited recourse borrowing arrangement (LRBA). The basic premise is, if the property runs over multiple titles, each title will require its own bare trust, trustee and LRBA. The Australian Tax Office (ATO) has clarified certain scenarios that it is permissible to have just one LRBA, and where multiple LRBAs would be required.

Single LRBA required in these scenarios:

  • factory complex that runs over multiple titles and therefore cannot separately sell titles
  • house and land package
  • completed ‘off the plan’ property – if cash paid for the deposit, an LRBA can be used to pay balance
  • apartment with separate car parking space – although separate titles you can’t sell one without other, so one LRBA is ok
  • option to purchase a house (just the option) -if the house is then purchased, this must be done with separate arrangement as a different asset to the option.

Multiple LRBAs required in these scenarios:

  • if the vendor will only sell the two titles together (but it is legally permissible to sell them separately)
  • farmland with multiple titles-if no legal impediment to selling them separately
  • a block of land purchased – at a later date it is decided a house is to be built on block
  • a serviced apartment that is fully furnished – the apartment and furniture are seen as two separate assets.

With A SMSF property purchase there can be substantial fees and charges associated with the purchase, ownership and subsequent sale of a property in an SMSF arrangement. These will eat into your super balance so you need to ensure the income in the super fund will cover these costs and allow for growth. Many people assume that if they contribute personal money 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 this is considered a personal contribution to your super fund and cannot be withdrawn until you meet preservation age.

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