Investing in property though 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 really do need to make sure you know what you’re getting into. Here is our guide to buying property through your SMSF.
A self managed superannuation fund (SMSF) gives your property investment flexibility. With an SMSF, you can invest directly in residential or commercial property using the funds you’ve accumulated in super.
As a trustee of an SMSF (or a director of the corporate trustee) you can:
- choose which property the fund buys
- manage the rent received and any expenses
- decide when to sell.
But there are some important rules that apply to the purchase of property as an investment for your SMSF.
INVESTING IN RESIDENTIAL PROPERTY
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.
The benefits of buying property through SMSF
Lower Tax Rates
Purchasing an investment property through your SMSF gives you great tax incentives. Rental income is taxed at 15% and you only pay 10% on capital gains if the property is held for over a year. Both of these become 0% if you’ve retired and are receiving a pension from the fund.
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%.
That means that if you decide to keep the investment once you have retired and your SMSF owns the property outright, the rent is not taxed. That means you get to keep 100% of it! You can even invest this income into another investment property, further growing your wealth.
When personal income tax rates can be up to 47%, an SMSF property is an attractive proposition. Even if a company you own has an investment property, tax on it is 30%.
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.
Making repayments from pre-tax dollars
If you can afford to save and have room within your concessional contribution limits then you can salary sacrifice additional income to super to pay off the loan quicker from pre-tax dollars. So paying 15% on salary sacrifice and then making additional repayments rather than paying your marginal tax rate on the income and saving it outside super.
Combined investing as a couple or family
Your personal savings outside superannuation – or even your individual account balance(s) within superannuation – may not be enough to meet the deposit requirements of a direct property. Combining your account balances with the other members of your family, though, may give you the purchasing power you need to invest in a large asset.
Buy your retirement home now
Residential property investments are a bit trickier, because you, your family or your friends can’t live in the property. However, if you plan on retiring somewhere else, you can buy a home, rent it out and once you retire and receive a pension from your fund, transfer the property from your fund to your personal name.
This could be a great option for those wanting to take advantage of lower property prices to buy that dream house on the coast whilst generating income for your retirement.
You may be considering taking advantage of the substantial tax incentives on offer. With the right planning for your circumstances, you can maximise your wealth. If you want to learn more about SMSFs, download an information pack today.
We've created an SMSF Guide here:
Beneficial for business owners – Your business can rent premises from your fund
Generally speaking, you can’t buy an investment property and live in it, or rent it out to family or friends. This is because the investment must be for the sole purpose of providing for your retirement. However, if you run a business, you can purchase a commercial property with your SMSF and lease it out to your business. Why pay a landlord when you can pay for the retirement you want?
Your business pays a rental amount, calculated at market rate, into your SMSF, which is tax deductible against your business income. Importantly, this rent is not classified as a superannuation contribution, so you can still make concessional and non-concessional contributions, subject to your age and any contribution caps.
An effective way to diversify your super investments.
Investing in the property market using a self managed fund allows you to dabble in all kinds of property, including residential, commercial and industrial.
Most commonly, people use their SMSF to buy a commercial property to lease back through their business. But there are a few specific conditions you need to be aware of if you’re considering this:
Commercially competitive: The terms of the lease must be commercially competitive. You aren’t allowed to lease it back for “mates’ rates” to give yourself a financial advantage. The ATO monitors and audits SMSFs regularly to ensure all arrangements are compliant.
No rental holiday: When things get tight and there’s an income downturn, you aren’t allowed to skip the rent for a payment. The payments must be made on time, every time, in full.
Valuations: Compliance of the SMSF relies on regular valuations being done on the commercial property. This can be time consuming and requires a lot of paperwork.
Sole purpose test: The investment must satisfy the ‘sole purpose’ test, which is that its sole purpose is to provide retirement benefit to the fund’s members.
Big lumpy illiquid asset.
Diversification – the wise move of not having all your eggs in one basket is more difficult to achieve if your SMSF owns just one or two large assets. That lack of diversification may not be in the best interests of the SMSF members especially across generations. The old adage “You can sell off a bathroom when you need cash” comes to mind so make sure you plan your “what if strategies” and look at insurance, cash buffers and especially the funding of future pensions upfront.
Set up costs are higher.
There are thousands of dollars in set-up costs and there are sometimes higher fees involved in getting a loan through your SMSF with lenders. As always set up costs should be balanced against long term benefits of the strategy. Because of the costs buying property through a SMSF is generally only suitable for funds with $200,000 or more.
Not great for Negative Gearing.
If you borrow to buy property through your super and you’re negatively geared, the tax offset only applies to other income earned within the fund taxed at only 15% – not at your marginal tax rate on your regular income.
Higher costs - SMSF property loans tend to be more costly than other property loans which must be factored into your investment decision.
Cash flow - Loan repayments must be made from your SMSF which means your fund must always have sufficient liquidity or cash flow to meet the loan repayments.
Hard to cancel - If your SMSF property loan documentation and contract is not set up correctly unwinding the arrangement may not be allowed and you may be required to sell the property, potentially causing substantial losses to the SMSF.
Possible tax losses - Any tax losses from the property cannot be offset against your taxable income outside the fund.
No alterations to the property - Until the SMSF property loan is paid off alterations to a property cannot be made if they change the character of the property.
You cannot benefit personally from the property.
Investments within a SMSF must be purchased via an ‘arm’s length’ transaction and must be maintained on a strict commercial basis. As such with a residential property, you cannot purchase from, lease to, or rent to a related party. The ATO advises that one of the most common breaches of the sole purpose test is in assets that provide a pre-retirement benefit to a member or associate. Some examples of a breach would be using a SMSF property as a personal holiday house, or renting a SMSF property to a family member.
You must be certain of future cash flow.
Firstly you must expect to have to provide a higher deposit than if borrowing directly. While you can borrow to buy property within a SMSF, you cannot borrow to build or improve the property. Ensure that your level of contributions, plus the rental income, will be enough to cover any costs that you will need to meet from cash. Think seriously about having decent Income Protection insurance as well as Life and TPD insurance for the term of the loan. Again, a cash buffer is essential.
Liquidity at retirement.
When your superannuation transfers to the pension phase you will need to ensure that you have built up a sufficient amount of cash to fund the required pension payments without risking a fire sale of the property. This can range from 4% of the pension member’s balance before 65 to 5% from 65-74 and upwards from there.
Reduction in Personal borrowing capacity
With banks typically asking for personal guarantees now which then restricts your personal borrowing power.
If you want to buy an investment property using your SMSF, but haven’t accumulated quite enough super, your fund may be able to borrow the money.
Lenders will generally require your SMSF to have a corporate trustee structure and may allow your fund to borrow up to 80% of the value of a property.
Borrowing or gearing your super into property must be done under very strict borrowing conditions called a 'limited recourse borrowing arrangement'.
A limited recourse borrowing arrangement can only be used to purchase a single asset, for example a residential or commercial property. Before committing to a geared property investment you should assess whether the investment is consistent with the investment strategy and risk profile of the fund.