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 speak to a specialist? Book a complimentary discovery session by calling: (03)999 81940 or emailing team@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
It's possible that the balance(s) of your individual account(s) within superannuation, or even the personal assets you have that are outside of superannuation, won't be enough to satisfy the deposit requirements of a direct property. However, if you combine the balances of your accounts with those of other family members, you could be able to acquire the purchasing power that is necessary to make an investment in a significant 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
Large, illiquid, lumpy asset.
The smart strategy of not placing all of your eggs in one basket, which is referred to as diversification, becomes more difficult to implement if your SMSF only holds one or two significant assets. It is possible that the best interests of the SMSF members are not being served by this lack of diversity, particularly across generations. Be sure to put together a "what if" strategy that includes insurance, financial reserves, and, most notably, the payment of future pensions in advance. When you're strapped for cash, the proverbial "you can sell a toilet" comes to mind.
The price of setup is 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.
Negative gearing is not good
If you borrow money to acquire property through your super and you are negatively geared, the tax offset only applies to other income earned inside the fund that is taxed at just 15% rather than at your marginal tax rate on your regular income. This is because the other income is taxed at only 15%.
You need to take into account the fact that SMSF property loans are often more expensive than ordinary property loans. This is something that you need to keep in mind.
Cash flow - Since loans must be repaid from SMSFs, these funds must always have enough liquidity or cash flow to cover the loans.
If the documents and contract for your SMSF property loan are not properly put up, you may not be able to unravel the agreement, and you may be forced to sell the property, which could result in significant losses for the SMSF. If the agreement is difficult to cancel, the SMSF may suffer significant losses.
Tax losses that may be incurred - Any tax losses that may be incurred as a consequence of the property cannot be used in any way outside of the fund to lower your taxable income.
No improvements can be made to the house until the SMSF property loan is paid off since any alterations that would have an effect on the nature of the home cannot be made until then.
You cannot exploit the property for your own benefit
Investments made by an SMSF are required to be obtained through a transaction known as "arm's length," and they must be maintained in strict accordance with the norms of commercial activity. As a consequence of this, while you are buying or renting a residential property, you are not permitted to buy from, lease to, or rent to a related party. According to the ATO, one of the most common types of violations of the sole purpose test is the ownership of assets that provide a member or associate with a pre-retirement benefit. Two examples of infractions are when a property owned by an SMSF is used for personal holiday purposes or when an SMSF property is rented out to a member of the same family.
Future cash flow must be assured
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.
Flow of funds after retirement
You have to make sure that you have saved enough money before you enter the pension phase of your superannuation so that you will be able to afford the necessary pension payments without having to risk having to sell your house to pay for them. This can range anywhere from 4% of the pension member's remaining balance up until the age of 65 to 5% of the member's remaining balance after that age.
Would you like to speak to a specialist? Book a complimentary discovery session by calling: (03)999 81940 or emailing team@klearpicture.com.au.
Reduced capacity for borrowing money by people
Your capacity to borrow money on your own is hindered by the fact that banks more frequently require personal guarantees.
If you want to utilise your SMSF to buy an investment property but don't have enough money in your retirement account, your fund might be able to take out a loan to get the money it needs.
Your Self-Managed Superannuation Fund (SMSF) may be allowed to borrow up to 80% of the value of a property if it has a corporate trustee structure, which is typically required by lenders.
When taking out a loan or investing your retirement funds in real estate, you are required to employ something called a "limited recourse borrowing agreement."
A limited recourse borrowing arrangement is the only type of financing that can be utilised when purchasing a single asset such as a residential or commercial property. Before making a commitment, you need to determine whether or not investing in geared real estate is compatible with the investment strategy and risk profile of the fund you are considering.
