Individuals can have complete control over the investments made with their retirement savings by establishing a self-managed super fund, often known as an SMSF. These investments can be made in the form of shares, term deposits, or real estate.

According to the Australian Taxation Office (ATO), there were approximately 600,000 SMSFs in Australia as of June 2019 and more than 1.1 million members.

It was estimated that the overall value of the assets owned by SMSFs would come to $748 million, with listed shares accounting for 31% of this total value, followed by cash and term deposits (21 percent ).

Even if it makes up only about 13 percent of your total portfolio, real estate could still be an excellent option for you.

Because the processes and rules involved are rather sophisticated, you should read on to determine whether or not it is a strategy that could be beneficial for your fund.

Would you like to speak to a specialist? Book a complimentary discovery session by calling: (03)999 81940 or emailing team@klearpicture.com.au.

Simply put, what is an SMSF?

An SMSF, or self-managed superannuation fund, is a private superannuation fund that is managed solely by you as opposed to being handled by a superannuation provider like "Australian Super" or "QSuper."

Every single one of its members—at most there could be four of them—is required to serve as trustees. This suggests that each member of the fund is equally responsible for making decisions that affect the fund, as well as ensuring that the fund adheres to any applicable legislation.

In addition to this, a trustee is expected to

• Utilize a method of investment that will assist you in meeting your retirement objectives while maintaining a level of risk that is suitable for you.
• Be equipped with the financial knowledge necessary to make judgments on investments.
• Maintain thorough documents for audits
• Consider providing participants in the fund with insurance.

A superannuation account is a retirement savings account that your employer is legally required to contribute to and that you are not permitted to use until you reach the "preservation age," which varies from 55 to 60 years old depending on when you were born. Your employer is legally required to contribute to your superannuation account.

A self-managed super fund, or SMSF, is a type of retirement savings vehicle that gives you more control over your retirement savings, including how much you contribute, where that money is placed, and how much of it is invested.

Even while in practise it may not be so clear, administering SMSFs is a massive undertaking that requires a significant investment of both time and effort.

In addition, they come with a significant amount of charges associated with fees and the hire of specialists to assist you, such as accountants.

Can an SMSF be used to purchase residential real estate?

Although it is possible for an SMSF to purchase a home, there are a number of limitations:

• You or anybody associated to the trustee are not allowed to live in a residential property that you have purchased with money from the SMSF.
• It is against the rules for a trustee or anybody else related to the trustee to rent out any property that was purchased using the SMSF.
• It is not possible for the SMSF to buy a property that is already owned by a trustee or by a person who is connected to a trustee.
• The acquisition needs to be able to pass the "sole purpose test," which stipulates that it can only be used to deliver retirement benefits to fund members.

The objective of the single purpose test is to guarantee that the SMSF will only be used to provide benefits to members upon retirement or to their dependents in the event that the member passes away prior to retirement. It is, in essence, the golden rule for investing in property through an SMSF.

In addition, it is not allowed to purchase an existing residential property that is held in the trustee's name and then incorporate that property into the SMSF.

It is also essential to have a solid understanding of the considerable differences that exist between purchasing a house with money from the SMSF and doing so with an SMSF home loan. We won't be getting into it just yet since it's an entirely new kettle of fish that's far more difficult to understand.

Is it a wise idea to use an SMSF to purchase real estate?

Yannick Leko, the founder of SMSF Loan Experts, believes that utilising your super fund to purchase real estate can be smart because it can increase your retirement savings and offer some of the best tax benefits available.

He did remark, though, that the constraints and standards might prove to be counterproductive.

With the right loan optimisation, self-managed super fund structure, and property type, your fund might be several hundreds of thousands of dollars larger when you retire if you take the appropriate steps.

"The vast majority of loans offered by self-managed super funds are stringent and restrictive. This means that in most cases, you will be obliged to pay a higher interest rate, and there will be limitations placed on the types of real estate that you can borrow money against from your super fund.

"Despite the fact that real estate lawyers, bankers, accountants, and financial advisors are all exceptionally skilled in their respective fields, it can be challenging for these professionals to adequately comprehend everything that is associated with self-managed super fund, or SMSF, loans due to the complexity of the relevant laws and regulations.

It is a common practise for many self-managed super funds to acquire non-compliant structures, lost deposits, or loans that limit the return on their investment.

Can you purchase commercial property with an SMSF?

The purchase of residential real estate by SMSF investors is often less common than the purchase of commercial real estate.

When purchasing commercial property through an SMSF, you are subject to the same constraints as when purchasing residential property, such as the requirement that the property serve only one purpose.

Many small and medium-sized firms (SMEs) may use a self-managed super fund (SMSF) to purchase commercial real estate, after which they will lease it back to themselves while still paying rent to the SMSF.

This is allowed so long as there is a "arm's length basis" maintained between the two parties. This indicates that all investments need to have stringent management, and that asset values need to be adjusted so that they accurately reflect current market conditions.

If you are considering doing it, there are many requirements you need to fulfil in addition to the test for a single purpose, including the following:

• The lease's conditions must be economically reasonable and competitively priced. In order to save money, you cannot lease the property to your business partners at rates that are significantly below market value.
• To make sure the rent you are paying is the appropriate market value, you must have the property regularly valued.
• Rent must always be paid in full and on time. Just like in any other rental arrangement, you cannot be a day or two late because you had a disappointing week. In the event that you do not adhere to these restrictions, the compliance status of your lease will be revoked. It is not worth it to engage in rule breaking since SMSFs are scrutinised by the ATO, which conducts frequent audits of them to verify that their members are in compliance with the regulations. In addition to that, you are obligated to perform an annual audit on yourself.

Can an SMSF obtain a loan to purchase real estate?

It is feasible to receive a loan to purchase real estate through an SMSF; however, there are a lot of complicated regulations that must be met.

All loans made to SMSFs must be made through a limited recourse borrowing agreement (LRBA). As a result, a separate trust and trustee—known as a custodian—must be put up to minimise risk to other assets inside the fund in order to limit the lender's recourse.

If the SMSF is unable to make its loan payments and falls behind in its obligations, the lender will make an effort to reclaim its losses by seizing assets owned by the SMSF.

Because the SMSF property is held in a distinct trust from the SMSF itself, lenders often do not have legal standing to go for SMSF assets. Because of this, the assets are typically shielded from the threat of the lender seizing and repossessing them.

Before engaging into an LRBA, you need to consider whether or not the SMSF has the capacity to resist increases in interest rates, whether or not the loan can be sold to a third party, and whether or not the asset you plan to use the money to acquire fulfils the "sole purpose test."

You have the ability to put the money that you borrow from an LRBA towards the purchase of real estate as well as the maintenance and repairs of a property that the SMSF owns. It is not possible to make enhancements to the property with money that has been borrowed. Some examples of improvements include adding on to a home, constructing a granny flat, or extending it.

You are permitted to utilise borrowed funds for the aforementioned initiatives; this is due to the fact that the alterations in question constitute repairs and include returning the component to its initial condition.

Therefore, you might want to consider getting a loan to pay for the cost of purchasing a new kitchen tabletop to replace the old one that is damaged. You would not, however, be able to use money that you had borrowed to pay to have that bench extended because it would be considered an improvement. Simple, yes?

In today's world, getting an LRBA might be somewhat challenging. The big four banks and a great number of smaller companies no longer offer these products because of the complexities involved and the low profit margins they offer. The following financial institutions were still offering loans to SMSFs at the time this article was written:

• La Trobe Financial
• Liberty Financial
• Bank of Queensland (BOQ)
• Switzer Home Loans
• Mortgage House
• Freedom Lenders
• Reduce Home Loans
• Rate Chaser Home Loans
• LJ Hooker Home Loans
• Regional Australia Bank

Using an LRBA to purchase a property through an SMSF

The steps involved in purchasing a home through an LRBA are quite similar to those involved in purchasing a traditional home. The key difference is in how difficult it is to fill out the application; trustees run the danger of incurring significant fines totalling over $200,000 if the application is correctly structured or compliant. You should look for a mortgage broker and an accountant that can walk you through the process and help you understand everything that is going on.

The following is an outline of the application process for your reference:

1. After examining possible capital gains, rental income, market value, and any compliance difficulties, the trustee and additional trustees (if applicable) pick a property that you wish to acquire.
2. The property has a custodian designated to it. The custodian, a bare trustee, holds the title to the property until the debt is fully repaid.
3. You submit your application together with the required paperwork.
4. The contracts to purchase the property are now being exchanged, and the custodian is responsible for making the down payment.
5. Should the lender decide to grant you the loan, the custodian will put the property up for collateral with the lender by offering it to them as security. This will allow the transaction to be finalised and will allow the lender to pay the legal and stamp duty fees.
6. You start your repayments and start collecting rent after the loan has settled. Internal SMSF funds must cover your payments if the rent is not enough to cover them.
7. After the loan has been paid off, the SMSF may request that the title be transferred from the custodian to themselves.

What are the tax repercussions of investing in property through an SMSF?

One of the primary reasons individuals use an SMSF to purchase real estate is so they may take advantage of any potential tax advantages.

Just like with an individual's tax return, the amount of the fund's income that is subject to taxation is equal to the fund's gross income, less any deductions that are permitted. The majority of tax rates are much higher than the tax rate that applies to SMSFs, which means that the SMSF tax rate is only 15% during the fund-building phase. During the time that your SMSF is in the pension phase, you will enjoy a total absence of tax liability.

Only compliant funds are eligible for the tax rate of 15%; if your fund is non-compliant, which means you have either been issued a notice of non-compliance or you aren't an Australian resident, you could be subject to a tax rate of 45%.

The capital gains tax (CGT) discount should be taken into account when analysing the tax implications of SMSF property investments. You can either make a capital gain when you sell a property for more than you paid for it or a capital loss when you sell it for less than you paid for it. With the capital gain added to your assessable income, CGT is the tax paid on the profit from the sale of your property. This can significantly raise your taxable income.

When a property owned by an SMSF is sold before one year has passed, the CGT is calculated at the usual tax rate of 15%. (in the accumulation phase). However, if the property is sold after a year of ownership, the SMSF obtains a one-third tax credit on any capital gain it achieves from the sale, bringing the CGT down to 10%. This is done to discourage investors from flipping homes too quickly. No CGT is due if the property is sold during the pension phase.

If the property was purchased with the help of an SMSF loan, there is a possibility that you will profit from the tax advantages. There is a possibility that the SMSF will be able to deduct the interest payments that have been made on the loan. In addition, the taxable loss can be carried over from year to year to lower taxable income in the years to come, provided that your total rental expenses are greater than your total rental income.

Tax is the lone wolf when it comes to financial concepts; it usually confounds, confuses, and complicates matters that would typically be easy if it were not included. Make use of the material that we have provided as a general guide; if you have specific difficulties, get in touch with the ATO or visit their website. This is especially important to do if the sole reason you are establishing your SMSF is for the tax benefits it will provide. Before making any significant choices, it is highly recommended that you seek the guidance of an experienced tax professional first.

Considerations to make when purchasing a home through an SMSF

When trying to purchase a property through an SMSF, there are various considerations you need to take into account in addition to the numerous restrictions, requirements, laws, and red tape. These should be taken into account before making an investment in real estate. After buying a property, taking these factors into consideration could result in less than stellar financial outcomes for your SMSF.

Financial impact

When an SMSF transitions into the pension phase, the law requires that it pay out a minimum pension payout, the amount of which increases based on the ages of the trustees. Because of this, a Self-Managed Superannuation Fund (SMSF) is required to hold a diverse portfolio of assets, including a range of shares, cash, and real estate.

Even if one asset class starts to perform less well, the other assets can continue to benefit the members of the fund in accordance with the "single purpose test," often known as the "golden rule." This is because of the diversification of the assets.

Cash and equities are generally considered to be more liquid assets than real estate, which is due to the fact that they can be accessed more easily and moved around more freely. The property, on the other hand, is about as non-liquid an asset as you can find; it is stiff, difficult to sell, and difficult to access the equity or value that it contains. Because of this, keeping it in a self-managed super fund, or SMSF, might be risky because doing so limits your access to liquid assets, which could cause your fund to fail the single-purpose test. It is essential that the selling of the property be given as much careful consideration as the buying of the property itself.

Compliance

The magnitude and significance of the compliance that comes with acquiring a property through an SMSF has already been emphasised multiple times throughout the essay. This is because the compliance is associated with purchasing a property through an SMSF. Even while it is already a major investment on your part to audit your SMSF once a year as required by the law, the ATO also conducts frequent audits of SMSFs to ensure that they are running in compliance.

Although it is possible to outsource a significant portion of the labour required to be polite, the expense of doing so frequently renders your particular SMSF efforts pointless. The fact that compliance and SMSF work hand in hand is a significant contributor to the anxiety that is associated with investing in property through an SMSF.

Expenses

Because SMSF property investments come with a wide range of expensive costs, investors frequently postpone making them. It might be expensive to hire a team of accountants, attorneys, and other professionals to make sure everything is legal and completed on time. Costs may comprise:

• Upfront fees
• Advice fees
• Legal fees
• Stamp duty
• Bank fees
• Ongoing property management fees

The vast majority of SMSFs pay significantly higher costs when compared to industry funds overall. A self-managed superannuation fund's (SMSF) expenditure ratio can be defined as the average yearly total cost of operating the fund represented as a percentage of the fund's balance. In 2017, the average expense ratio for a fund that was regulated by APRA was 0.8%. According to the information provided by ASIC, the expense ratio for an SMSF with a value of between $200,000 and $500,000 was 3.0%.

Further contributions

If you find that your fund does not have sufficient liquidity or if you require additional funds to pay off a debt that you have in an LRBA, you may decide to put some of your money in your self-managed superannuation fund (SMSF). It is essential to keep in mind that doing this counts as an additional contribution to your retirement fund, which means that you will not be able to access the money until you reach the age of retirement. You are not permitted to take money out of or add money to your SMSF at any time. Because of this, it is extremely important to go into the process of purchasing a property with a clear and well-defined plan for how you intend to invest the money.

Benefits and drawbacks of using an SMSF to purchase a property

Using a self-managed super fund (SMSF) to make property purchases enables you to significantly broaden the scope of your investment portfolio while also increasing the asset diversity of your fund. On the other hand, it typically comes with fees and issues complying with regulations. You may decide if it's the best choice for you by looking at a summary of its pros and downsides, which are as follows:

Pros

• Tax benefits: Purchasing real estate through an SMSF may offer trustees a sizable tax benefit. The average tax rate on super funds, including SMSFs, during the accumulation phase is 15%, which is significantly lower than the marginal tax rates paid by the majority of Australians. Your taxable income would also be reduced further if any capital gains on the property were taxed at a reduced rate of 10%.
• LRBA: By putting the property in a separate trust, a limited recourse buying arrangement can enable you to utilise borrowed money to acquire a property through an SMSF and make renovations to an existing one while also lowering the risk to other fund assets.
• Control: You have more financial control with an SMSF. If you use this money to buy property and then lease it back to yourself, it can be advantageous for your business. You must lawfully give the best financial outcome for your retirement in order to pass the sole purpose test.

Cons

• Time: Considerably while managing an SMSF can be a lot of work on its own, the complexities of buying a home through it can make matters even trickier. Of course, you can hire experts to help you, but you might still need to put in a lot of effort on your own. Your fund can have difficulties if you lack the time management skills and financial expertise to handle this.
• Costs: In addition to ordinary SMSF expenses, SMSF property investments generally involve a variety of fees. Additionally, you'll probably need to spend money—again—on the services of an accountant, at the absolute least, to guide you through the process. Without a set spending limit and plan, you can find yourself in trouble very soon.
• Risks: All real estate investments include some degree of difficulty, but it's arguable that SMSF investments are even more problematic. It could be a complicated and frustrating investing experience due to the amount of compliance that goes along with it, as well as the red tape, limits, and legislation.

What happens to my SMSF if I move overseas?

When you relocate abroad, self-managed super funds are treated a little differently than traditional superannuation. Before you say goodbye, find out what needs to be done.

The biggest "sticky" financial category you'll need to deal with before you leave Australian soil is probably superannuation. Superannuation remains with you for life, or at least until preservation age, unlike a bank account that you can close at any time. A separate set of factors are also relevant to self-managed super funds (SMSFs). Before moving abroad, take a look at the following with your SMSF.

SMSFs and Moving Abroad: What Should I Take Into Account?

If you are relocating overseas but are still considered an Australian resident for tax purposes, you are required to take steps to ensure that your SMSF maintains its "Australian" status so that you can continue to take advantage of favourable tax treatment, such as a tax rate of 15 percent. If you don't, the tax rate that applies to your SMSF will be the one that applies to the highest marginal income.

Keeping your SMSF's ownership in Australia

Three key criteria are used by the Australian Tax Office (ATO). In order to fulfil its residency requirements, SMSFs must:

• At least one of the investment firm's holdings is located in Australia, where the company's headquarters were initially established (for example, a property located in Sydney).
• Typically, the fund's central management and control operations are carried out in Australia. In most cases, this condition will be met if the management or control of your fund is based outside of the country for a period of up to two years.

Either there are no active members of the fund, or there are active members who are residents of Australia who hold at least fifty percent of either of the following:

• The total market value of the fund's assets that is attributable to super interests
• The sum of money that would be owed to active members in the event that they decided to withdraw from the fund.

If you are thinking of moving to another country, the second factor can end up being the most crucial for you. If you are just going to be living abroad for a short period of time—less than two years—for reasons such as a job contract, a working vacation, or as part of a longer trip, you probably do not need to be too concerned. If, on the other hand, you are thinking of being gone for a longer period of time, this is when things can start to get difficult for you.

Options for your SMSF when relocating permanently abroad

Should you relocate outside of Australia for more than two years, you'll need to make some changes to your SMSF unless you love paying more tax.

If your SMSF is a two-person fund, you'll probably also need to stop making contributions when you are abroad to maintain the "50 percent guideline" mentioned above. Here, the ATO suggests doing this. Keep in mind that giving your trustee "advice" or investing instructions may be against the law.

Wind up

Consider winding up the SMSF entirely if you're not ready to delegate the management of your investments to a trustee. This may be the case, in particular, if both of you are relocating abroad and your spouse is a member of the SMSF. Here, there are typically two choices:

• Large fund: You have the option of combining your investments into a standard, sizeable super fund; but, in order to do so, you will first need to transfer or sell your assets. These assets include your stocks, bonds, and other investments, as well as any real estate you own. Capital gains tax (CGT) may also be triggered; however, if the fund is paying retirement-phase pensions (i.e., if you're transferring abroad in retirement), you may be able to avoid this. If the fund is paying regular pensions, however, you may be subject to CGT.
• Small APRA fund (SAF): a SAF can have a maximum of four members, and those members are controlled by a licenced trustee. A SAF must adhere to certain regulations. Paying another individual to manage your investment may be expensive, but it will alleviate the worries of the trustee. You are required to quit making contributions because you will still run into the "active member" problem if you do so.

If you are going to be living outside of the country for an extended period of time, it may be beneficial to wind up your self-managed super fund and convert its assets into one of these other options. After you've taken care of everything else, the money for your retirement should be the absolute last thing on your mind.

Maintaining Australian residency vs. giving up residency in SMSFs

In Australia, if you have any income at all, you are required to submit a tax return regardless of how you want to present the information. If you continue to manage your SMSF while keeping your Australian residency and producing income or capital gains, you will most likely be subject to the tax rate that applies to non-residents.

There is no threshold at which non-residents are exempt from paying tax, and the tax rate for non-residents is higher than the tax rate for residents. In addition, if you are a non-resident and you have an SMSF, you run the risk of being in a "non-complying fund," which means that you will not be eligible for the preferential tax rate of 15%. If you are no longer legally allowed to call Australia home, the process of winding up your self-managed super fund (SMSF) may be easier.

Moving to New Zealand and SMSFs

The close relationship that exists between Australia and New Zealand makes it far less difficult to organise one's money when moving to either country than it is in most other countries. When you have regular superannuation, you often have the ability to move money from your APRA fund to an account called "KiwiSaver" in New Zealand. If you already have a number from the Inland Revenue Department (IRD), moving to the land of the long white cloud permanently isn't too difficult of a process for you to go through. It is unfortunate that this is not always the case with SMSFs; the limits that were discussed earlier still apply.

Would you like to speak to a specialist? Book a complimentary discovery session by calling: (03)999 81940 or emailing team@klearpicture.com.au.

Penalties for non-compliant SMSFs

If you continue to be an active trustee for your SMSF after moving overseas for more than two years, you face the risk of falling out of compliance with the regulations governing your fund. Because of this, in addition to any administrative penalties imposed by the ATO, it is possible that the concessional tax rate of 15% will no longer apply to your situation. In most jurisdictions, sentences are read out in blocks of units, typically ranging from 5 to 60 teams at a time. Because one violation of SMSF compliance results in a $210 fine, you might be responsible for paying $2,100 if you charged ten different companies for the same infraction. Your cash must be utilised for this purpose; your self-managed super fund (SMSF) cannot be accessed.