Superannuation is full of the terminology, but one term that's used quite a bit is "real business property". In a nutshell, it means property that's used by a business – for example, a factory, a shop or an office – as opposed to "residential property" which is property people live in.
Self-managed superannuation funds (SMSFs) are actually allowed to invest in both types – commercial property (or real business property) and residential property. So why does it matter how the property is classified?
Business real property is a crucial piece of superannuation language and has a particular meaning.
There are two occasions when SMSF trustees care a lot about whether a property is real business property.
The first is when the fund is first acquiring the property. If it's a real business property, the SMSF can acquire it from people or entities known as "related parties".
If it's not real business property, it can't be acquired from related parties. Several pages of law are devoted to defining related parties but, in brief, related parties are members of the SMSF, their families and other people with whom they have a partnership, as well as companies and trusts they or their family control. For example, if an SMSF was to buy a property from a member or, say, their family trust, the fund would be buying it from a related party. In that case, it would be important that the property was business real property.
Investing in property through a self-managed super fund (SMSF) has grown in popularity in recent years, particularly since it became possible for SMSFs to borrow money to fund a direct property purchase.
This is an area where you do need to make sure you know what you're getting into. Here is our guide to buying a property through your SMSF.
Thousands of Australian investors have taken control of their super funds and are using them to invest in property.
Self-managed super funds (SMSFs) have become the single biggest asset class in Australia. 2013 statistics show that the number of self-managed super funds registered each week in Australia is now over 1000.
This essential guide includes SMSF pros and cons, frequently asked questions and how to learn more if you are interested in setting one up yourself and pursuing this strategy.
What Is A Self-managed Super Fund (SMSF)?
A self-managed super fund is defined as a fund established by one to four people for the sole purpose of providing retirement benefits.
While SMSFs enjoy the same financial benefits and concessions as retail, corporate or industry super funds, the key difference and the attraction for many people is the ability for members to take personal control of the assets invested.
Investment decisions are made by the trustees who have the capacity to develop a range of financial strategies designed to cater to the specific needs of each member and to revise these approaches as circumstances change. An advantage is the ability to react quickly and decisively if an investment opportunity arises.
The members are also trustees of the fund, which means that they exercise full control over the investment and they are responsible for investment decisions.
What Property Can An Smsf Buy?
You can use your SMSF to buy residential or commercial property. However, any property held by your SMSF must meet the sole-purpose test of providing retirement benefits to fund members, or a benefit to their dependants if a member dies before retirement.
SMSF's are permitted to invest in residential property as long as you don't buy the property from a related party of a member.
For example, you can't own the family home through your super fund. Nor can you rent a residential property owned by your SMSF to a fund member, or to their related parties.
You can purchase an investment property that you rent to tenants who are not funded, members or relatives. 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 to it within the cap limits.
SMSF's are permitted to invest into commercial property, including your own business premises.
While the property still needs to meet the sole-purpose test of providing retirement benefits to its members, when dealing with commercial property, an SMSF can generally buy the property and lease it back to a member or a related party of the fund – including the member's business.
An arm's length sale price and lease arrangement is especially important when acquiring and/or leasing property to a member or related party of the fund.
We recommend that you speak with a financial adviser to help you decide if buying a property through your super fund is right for you.
Generally speaking, investing in commercial premises through an SMSF has some advantages over residential properties. The rules relating to holding residential property in an SMSF very clearly stipulate that the property can't be rented or occupied by you or any other trustee. It also can't be rented or occupied by any relation to the trustees.
Investors who think they can purchase a holiday house in their SMSF to enjoy over the summer will need to think again; the rules are clear and strict. Investors who already own an existing residential property can't transfer the property into an SMSF by acquiring it at market value or contributing it within the cap limits.
While commercial properties can be sold to an SMSF by its members, as well as being leased to SMSF trustees or an individual or business-related to them, there are still a host of considerations.
Holding commercial properties in an SMSF is open to all SMSF trustees, not just small business owners. To purchase a commercial property in an SMSF, a fund may apply for a specific SMSF loan. However, the criteria are stricter than traditional lending with tighter loan to value ratios.
Many small business owners use their SMSF to purchase 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 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.
Can An Smsf Buy A Commercial Property?
Yes. This is the method of property purchase that is allowable for SMSF. As laid out by the ATO, you can only buy a property through your SMSF if you comply with the following rules.
- Must meet the 'sole purpose test' of solely providing retirement benefits to fund members
- Must not be acquired from a related party of a member unless commercial property.
- Must not be lived in by a fund member or any fund members' related parties
- Must not be rented by a fund member or any fund members' related parties.
But your SMSF can purchase business property such as your own business' premises. This is an attractive option for SMSF trustees as it allows you to pay rent directly to your SMSF at the market rate. Many SMSFs choose to do this to help them to grow their SMSF fund for their retirement, and instead of paying rent to a landlord/third party with no financial gain.
It is advisable for a fund not to invest in one asset alone. So, there should be enough in a super to invest elsewhere, even when money has been used to buy the property. Or another option is to borrow to invest, but this in itself should not be seen as a cheap option. Loans that must be used when an SMSF borrows to buy property will generally have rates and required deposits at a higher amount than when borrowing at a personal level.
You can invest in property through a self-managed super fund (SMSF). You may be able to invest in property indirectly through listed property trusts or as part of a large diversified portfolio that invests in certain types of property such as infrastructure or commercial property.
SMSFs can invest directly in residential and commercial property.
An SMSF can buy business premises or investment properties. As trustee of your SMSF (or a director of the corporate trustee of the SMSF), you have greater control over which property (or properties) your fund invests in. You choose which property to buy, manage the rent and any expenses and decide when to sell.
Before your SMSF buys the property, you need to understand superannuation law and other relevant laws in this area. Importantly, the SMSF's trust deed must enable you to buy property, and property must form part of your fund's investment strategy. There are also restrictions on who you can buy property from and who it can be rented to.
We recommend that you speak with a financial adviser to help you decide if buying a property through your super fund is right for you.
For many small businesses and professional firms, one of the great benefits of an SMSF is your fund can take out a loan to buy the commercial property used by your business, and you become your own landlord.
You can indeed use your superannuation to purchase an investment property, whether it be a residential or commercial property. In order to do so, the first thing that you will need is to set up a Self Managed Super Fund (SMSF) which is the only option that will allow you to use your superannuation to purchase an investment property. There are other types of super funds out there, such as industry funds, retail super funds and super corporate funds. However, none of these allows you to purchase an investment property, so let's not worry about those. With an SMSF, you are able to invest from a wider range of investments than other super funds; however, there are very strict rules around investing in properties. For instance, your SMSF cannot be used to purchase a residential investment property from yourself, for any other member of the fund or a relative. Also, the property has to be rented out at market rent, and fund members or their relatives are not allowed to rent out the property.
"What's market rent?" We hear you ask. Market rent is the rent amount a willing landlord might reasonably expect to receive, and a willing tenant might reasonably expect to pay for a tenancy. It needs to be similar to the rent charged for similar properties in similar areas. Charge significantly above this amount, and potential tenants can appeal to the tenancy tribunal asking for the rent to be reduced.
How To Use Superannuation To Buy An Investment Property
To set up an SMSF, you need to ensure that you have enough funds available to make it a cost-effective option when used to purchase an investment property. There are ongoing costs associated with managing your own superannuation (kindly outlined for us by the ATO here), so you need to take these into account when doing your initial research. Whilst there is no legislated minimum balance required to set up an SMSF, you should take the time to compare the level of fees you are paying on your current super to the ongoing cost associated with operating the SMSF. The general consensus is that the bare minimum fund balance you would need is around $200,000, this allows for enough to cover the costs of not only the property but also any costs associated with SMSF as outlined by the ATO above. This increases to $500,000 if you plan on using an SMSF administration company to help with the administration and compliance tasks, as their fees will be higher.
What Are The Potential Tax Benefits Of Owning Property Inside My Superannuation?
Within the superannuation environment, rental income from investment properties is taxed at 15%. This rate also applies for Capital Gains Tax in the first year of ownership, after which it drops to 10% and no capital gains tax is payable on the sale of a property in the pension phase.
What are the rules around buying a commercial property from a related party?
The ATO has laid out very specific rules about buying a property through your SMSF. When buying a commercial or business real property through an SMSF, the rulings are different from residential.
'Business real property', such as commercial or industrial property, offices, warehouses, shops or even a farm, can be a legitimate SMSF investment. Residential property is also an allowable investment. However, with regards superannuation investments, the key difference is that, unlike residential property, an SMSF can buy real business property from related parties or fund members, and fund members or related parties (relatives of fund members) can use that SMSF asset if they choose to do so.
The Tax Consequences Of Buying And Renting The Property
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 in your SMSF
Borrowing to buy a 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 a recourse, and cannot access any remaining assets of the super fund.
Borrowing Criteria for SMSFs
Borrowing criteria for an SMSF is generally much stricter than a normal property loan that you might take out as an individual. The loan also comes with higher costs, which needs to be factored in 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.
If your primary purpose for wanting to have an SMSF is to purchase property with a mortgage you are then consulting with a bank or mortgage broker is strongly recommended before you even establish the super fund, to identify if you have sufficient funds 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.