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Pros and Cons of a Self Managed Super Fund (SMSF)

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    Since it became possible for SMSFs to borrow money to fund a direct property acquisition, investing in real estate through an SMSF has been more and more common in recent years.

    You should really make sure you understand what you're getting into in this area. Here is our advice on using your SMSF to purchase real estate.

    Your ability to invest in real estate is flexible with a self-managed superannuation fund (SMSF). Using the money you've saved up in super, you can use an SMSF to invest directly in residential or commercial real estate.

    You can: As a corporate trustee or trustee of an SMSF, you can:

    • select the property the fund will purchase.
    • Organize your rent payments and other expenses.
    • Pick a time to sell.

    However, there are several significant guidelines that must be followed when buying real estate for your SMSF.

    Would you like to a Melbourne SMSF specialist? Book a discovery session by calling (03) 9998 1940 or email info@klearpicture.com.au

    INVESTING IN RESIDENTIAL PROPERTY

    Regardless of how distant the relationship, you, another trustee, or anybody else related to the trustees are not permitted to reside in property acquired through an SMSF.

    You, another trustee, or someone affiliated with the trustees are also not permitted to rent the property. Therefore, purchasing a vacation house in your SMSF and relocating there for the summer is prohibited.

    Furthermore, you cannot contribute a residential investment property that you already own into an SMSF, either by having the fund buy it at market value or by having the contributor contribute up to the cap limitations.

    The advantages of using an SMSF to purchase property

    Reduced Tax Rates

    You can get excellent tax benefits when you buy an investment property using your SMSF. If the property is owned for more than a year, capital gains are taxed at a lower rate of 10% and rental income at 15%. If you have retired and are getting a pension from the fund, both of these decrease to 0%.

    The fund obtains a one-third reduction on any capital gain it realizes when selling properties held for more than a year, lowering any capital gains tax obligation to only 10%.

    This means that the rent is not taxed if you opt to keep the investment after retirement and your SMSF owns the home outright. That implies that you get to retain everything! Even better, you can use this revenue to buy another rental property, increasing your wealth.

    An SMSF property is a desirable option when personal income tax rates can reach up to 47%. Tax on investment properties is 30% no matter who owns the corporation that owns them.

    The fund's interest payments on a loan to buy the property are tax deductible. Each year, a taxable loss that results from expenses exceeding income is carried forward and can be applied to lower future taxable income.

    Any rental income or capital gains generated in the fund once trustees begin earning pensions after retirement will be tax-free.

    Also keep in mind that any tax losses you incur due to a loss on your property cannot be used to your own taxable income outside the fund.

    Using pre-tax funds to make repayments

    If you can afford to save money and have the capacity within your concessional contribution limits, you can salary sacrifice additional income to superannuation to pay off the loan more quickly using pre-tax monies if you have room in your limits. Instead of paying your marginal tax rate on the income and saving it outside of super, you should pay 15% as a salary sacrifice and then make further repayments.

    Investing collectively as a couple or family

    Your individual account balance(s) within superannuation, or even your personal assets outside of superannuation, may not be sufficient to satisfy the deposit requirements of a direct property. However, combining your account balances with those of your family members could provide you the purchasing power you require to make an investment in a substantial asset.

    Get a retirement residence immediately

    Investments in residential real estate are more challenging because you, your family, or your friends cannot reside there. However, if you want to retire someplace else, you can buy a house, rent it out, and then transfer the property from your fund to your personal name once you retire and start receiving a pension from it.

    This might be a fantastic alternative for people looking to buy their ideal home on the seaside at a reduced price while earning money for their retirement.

    Considerably generous tax incentives may be something you want to take advantage of. You may make the most of your riches with the appropriate planning for your situation. Download an information pack right away if you're interested in learning more about SMSFs.

    Here, we've produced an SMSF Guide:

    Beneficial for business owners – Your business can rent premises from your fund

    In general, it is not possible to purchase a rental property with the intention of living there or renting it out to relatives or friends. This is due to the requirement that the investment be made with the sole intent of funding your retirement. However, if you own a business, you can use your SMSF to buy a commercial property that you can then rent to your company. When you can fund the retirement you desire, why pay a landlord?

    A market-rate rental payment made by your company to your SMSF is tax-deductible from your company's gross revenue. You can still make concessional and non-concessional contributions, subject to your age and any contribution restrictions because this rent is not regarded as a superannuation payment.

    A good approach to diversify your investments in retirement accounts

    You can experiment with investing in various types of real estate, including residential, commercial, and industrial, by using a self-managed fund.

    Most frequently, individuals utilize their SMSF to purchase a commercial property to lease it back to their company. But if you're thinking of doing this, you need to be aware of a few particular circumstances:

    Commercially competitive: The lease's conditions must be favourable to businesses. You are not permitted to lease it back at "mates' rates" in order to benefit financially. The ATO constantly checks and audits SMSFs to make sure all arrangements are legal.

    You cannot take a break from paying your rent because times are hard or there is a decline in your income. The payments must be made completely and on time each time.

    Valuations: The regular valuation of the commercial property is necessary for the SMSF to be in compliance. It takes a lot of effort and paperwork to do this.

    The investment must pass the "sole purpose" criteria, according to which its only goal is to give fund members retirement benefits.

    The Disadvantages

    Big lumpy illiquid asset.

    If your SMSF only holds one or two sizable assets, diversification—the prudent approach of not putting all your eggs in one basket—becomes more challenging to achieve. The SMSF members' best interests may not be served by this lack of diversity, especially across generations. Make sure you prepare your "what if strategy" and include insurance, financial buffers, and notably the payment of future pensions upfront. As the saying goes, "You can sell off a toilet when you need cash."

    Set up costs are higher.

    Getting a loan through your SMSF with lenders involves additional fees and setup costs that might cost thousands of dollars. As always, it is important to balance the strategy's long-term advantages against its setup costs. Due to expenses, purchasing real estate through an SMSF is typically only feasible for funds with $200,000 or more.

    Not good for Negative Gearing.

    The tax offset only applies to other income made within the fund that is taxed at only 15% - not at your marginal tax rate on your regular income - if you borrow money to purchase property through your super and you are negatively geared.

    Higher costs - You must take into account the fact that SMSF property loans are typically more expensive than regular property loans.

    Cash flow - Since loans must be repaid from SMSFs, these funds must always have enough liquidity or cash flow to cover the loans.

    Hard to cancel - If the documents and contract for your SMSF property loan are not properly put up, you might not be able to unravel the agreement and be forced to sell the property, which could result in significant losses for the SMSF.

    Tax losses that may occur - Any tax losses that may result from the property cannot be used to reduce your taxable income outside of the fund.

    No property modifications - If the modifications change the character of the property, they cannot be undertaken until the SMSF property loan is repaid.

    You can't use the property for personal gain

    Investments made by an SMSF must be acquired through a "arm's length" transaction and must be kept in strict compliance with commercial principles. As a result, you cannot buy from, lease to, or rent to a related party when buying or renting a residential property. According to the ATO, assets that offer a member or associate a pre-retirement benefit constitute one of the most frequent violations of the single purpose test. Using an SMSF property as a personal vacation home or renting out an SMSF property to a relative are two examples of violations.

    The future financial flow must be certain

    First of all, be prepared to put down a larger deposit than you would if you were borrowing straight. While loans can be taken out to purchase real estate within an SMSF, they cannot be used to construct or enhance the property. Make sure your level of contributions and rental revenue will be sufficient to cover any expenses that require cash payments. Consider carefully purchasing adequate Life, TPD, and Income Protection insurance for the duration of the loan. Again, having a cash reserve is crucial.

    Cash flow after retirement

    You must make sure you have saved enough money when your superannuation enters the pension phase so that you can afford the needed pension payments without having to risk a house fire sale. This can range from 4% of the pension member's remaining balance until age 65 to 5% from that point onwards.

    Reduced ability of individuals to borrow money

    Banks now frequently want personal guarantees, which limits your ability to borrow on your own.

    If you wish to use your SMSF to purchase an investment property but haven't accrued enough super, your fund may be able to borrow the funds.

    Lenders often demand a corporate trustee structure for your SMSF and may permit your fund to borrow up to 80% of the value of a property.

    A "limited recourse borrowing arrangement" must be used when borrowing money or putting your superannuation into real estate.

    A single asset, such as a residential or commercial property, may only be bought using a limited recourse borrowing agreement. You should consider whether an investment in geared real estate is consistent with the fund's investment strategy and risk profile before making a commitment.

    Would you like to speak to a Melbourne SMSF specialist? Book a discovery session by calling (03) 9998 1940 or email info@klearpicture.com.au

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