The majority of Australians find superannuation to be a very straightforward concept.
You and/or your employer make regular contributions to an industry superannuation fund of your choice, and those contributions are then invested on your behalf – typically into shares – in the hopes that by the time you reach retirement age, your superannuation balance will have grown large enough to allow you to live comfortably for the remaining years of your life.
However, there are a variety of options available for investing in Australian retirement savings, and an increasing number of people are choosing to take charge of their own superannuation by establishing an SMSF, also known as a self-managed super fund. This gives them the ability to choose when and where their retirement savings are invested on their own accord.
The use of a self-managed super fund (SMSF) to purchase real estate is gaining popularity, but before you make a purchase using your SMSF, you should give it some careful thought.
Would you like to speak to a specialist? Book a complimentary discovery session by calling: (03)999 81940 or emailing team@klearpicture.com.au.
What exactly is a Self-Managed Super Fund, known as an SMSF?
A self-managed super fund also referred to as an SMSF, is a type of retirement savings account that is managed by the account holder themselves as opposed to being handled by a superannuation provider.
The do-it-yourself super technique gives you the opportunity to maintain a closer relationship with the assets that you invest in and provides tax advantages that are not offered by major suppliers.
On the other hand, you will have a great deal more responsibility because you will be in charge of everything and will be responsible for ensuring that it is organized and managed appropriately.
SMSFs are not appropriate for everyone because they require a lot of effort and study on the investor's part. While some people flourish when given additional responsibility, others struggle to meet the challenge.
Is it possible to utilize your Self-Managed Super Fund (SMSF) to purchase a piece of real estate?
The use of self-managed super funds (SMSFs), which can be put toward the purchase of investment properties, has grown in popularity among Australians in recent years.
A fund that is self-managed may even borrow money in order to purchase a single asset or a collection of assets that are all the same and have the same value on the market.
The use of limited recourse borrowing arrangements (LRBA), which are largely responsible for the rise in popularity of property purchases made using SMSFs, is a common method for accomplishing this goal.
In this particular approach, the trustees of the SMSF take possession of the beneficial interest in the item that has been purchased, while the trust retains legal ownership of the asset.
Property regulations for self-managed superannuation funds (SMSF)
When you invest in the real estate market through a self-managed fund, you have the opportunity to speculate on the value of various types of property, including residential, commercial, and industrial real estate.
Nevertheless, you are obligated to think about which property class suits your needs the most and to adhere to the rules.
Any piece of real estate in which you invest must:
- pass the "sole purpose test," which requires that the organization be maintained for the only purpose of providing retirement benefits to its members;
- not be occupied by a person or business that is connected in any way to the member;
- cannot be purchased from a party related to the seller;
- not be rented by a person or business connected in any way to a member of the fund.
The positive aspect of using an LRBA is that if you default on the loan, your whole retirement account will not be jeopardized. There are also limitations placed on the means by which a creditor might recoup their losses.
Purchase of a residence using a self-managed super fund
You should be aware that you are not permitted to buy a residential property through your SMSF if you intend to live in the property or if any member of your family intends to live in the property.
You are permitted to utilize your superannuation funds to purchase an investment property; but, you cannot use those funds to purchase a home for personal occupancy. This purchase is made through your self-managed super fund (SMSF), which is a type of fund that can have anywhere from one to four members and gives those members the ability to make their own decisions about how their superannuation is invested collectively as a group.
Naturally, this might still refer to stock investments, but with the real estate market seeing incredible development over the past ten years, many people have begun to include homes in their retirement and investment strategies.
The process of establishing a self-managed superannuation fund (SMSF) is highly regulated; therefore, it is strongly recommended that you seek professional financial counsel so that you may understand your duties and correctly establish the fund.
A documented investment strategy is another thing that the members of the SMSF (the trustees) are expected to have. This investment strategy is a comprehensive financial plan that is based on the current and future needs of each member of the fund.
The SMSF trustee, as well as any of their relatives and the members of the fund, are not permitted to derive any benefits from the property, as this is one of the conditions of the agreement.
To summarize, you can make an investment in residential property, but you can only do so with the intention of renting it out to customers.
What are the benefits of doing so?
Purchasing real estate through a self-managed super fund (SMSF) comes with a number of important benefits. To begin, the tax rate that will be applied to your superannuation fund is 15%, which is significantly less than the personal tax rate that the majority of individuals are subject to.
The second benefit is that the tax on your capital gains will be reduced.
If the asset is sold while the investor is still in the accumulation phase, the rate at which the capital gains tax is calculated is reduced.
If you sell the asset while the super fund is in its pension phase, you won't have to pay any tax on the profit from the sale of the asset.
If, on the other hand, you intend to establish an SMSF for the sole purpose of investing in real estate, be it residential or commercial, there are a few considerations you should keep in mind.
What are some of the Negative Aspects?
You are accountable for Compliance
Because they are specific to SMSFs, the rules and obligations that come along with being able to use borrowings to purchase property in your SMSF are very stringent, and it is possible that you are not familiar with them because they are not requirements that are imposed on entities that are not SMSFs.
As a result of the fact that trustees are not made aware of these regulations until after an audit of their fund, it is highly typical for trustees to unwittingly break these rules.
Because the ATO will hold you responsible for whatever you do as a trustee, it is your responsibility to educate yourself on the things you may and cannot do.
When things aren't done exactly as they should be, there is a possibility of expensive ramifications, such as trustee penalties levied by the ATO or implications for stamp duty.
Even if they bring in a third party to assist them or one of the other members or trustees makes a choice, each trustee is personally responsible for any and all decisions that are made by the fund. When you take on the responsibility of managing your own retirement savings, it is essential to get the assistance of knowledgeable professionals who have earned appropriate credentials in this field.
Expenses and costs associated with acquiring a property
When purchasing real estate via an SMSF, maintaining ownership of that property, and eventually selling it, there may be significant costs and fees involved. These will take a bite out of your super balance, so you need to be sure that the income that is being contributed to the super fund is sufficient to meet these costs as well as allow for development.
A lot of people are under the impression that if they put their own money into the purchase, then after the retirement fund has enough money, they would be able to pay themselves back. This is not the situation at all. You have the option of contributing some of your own money toward the purchase of the property; however, this will be counted as a personal contribution to your retirement fund, and you will not be able to access it before you reach the preservation age.
Funds for Renovating your property can only be funds from the SMSF
Borrowed money can be used to pay for very minor and straightforward upkeep and repairs that need to be done to the property. If you intend to make large modifications or renovations to the property, this is permitted; however, the work must be financed using cash that is already available inside the super fund and cannot be paid for with a loan or money that is borrowed.
You are not permitted to make significant adjustments to the asset that was initially purchased with the limited recourse loan agreement. Any improvements that have a significant impact on the asset will need the establishment of a new limited recourse borrowing arrangement.
There are many limitations to borrowing
When you borrow against your retirement savings or gear them up to invest in property, you are subject to highly stringent borrowing terms. This kind of borrowing agreement is known as a "limited recourse borrowing arrangement." With the funds from a limited recourse borrowing agreement, you are only able to purchase a single asset. A good illustration of this would be a residential or business property.
You need to determine whether or not the investment fits in with the fund's investment strategy and risk profile before making the transaction.
The criteria for borrowing money for an SMSF are typically quite a bit more stringent than those for a standard property loan that you may take out as an individual. When determining whether or not the investment will be profitable, it is essential to take into consideration the additional expenditures that will be incurred due to the loan.
A limited recourse borrowing arrangement is used when financing the purchase of real estate through a self-managed superannuation fund (SMSF) (LRBA).
A separate property trust and trustee are established to hold the property on behalf of the super fund, which is held outside of the real SMSF structure. This is done to "limit the recourse" of the lender, which means to "restrict" the lender's ability to take legal action against the borrower. The bank account of the retirement fund is used for handling all of the property's financial transactions, including both revenue and expenses. The retirement fund is responsible for making all necessary loan repayments. If the super fund does to comply with this requirement, the lender's only option for recourse is the property that is kept in the separate trust; they will not be able to access the super fund's other assets (if any).
At this time, the conventional wisdom holds that the majority of financial institutions will not even contemplate making a loan to an SMSF unless the fund has a balance of at least two hundred thousand dollars.
If the primary reason you want to have a self-managed super fund (SMSF) is to buy a house with a mortgage, then it is strongly recommended that you consult with a bank or mortgage broker before you even establish the super fund. This will allow you to determine whether or not you have a sufficient amount of money in super to obtain financing.
Keep in mind that your self-managed super fund (SMSF) must be used to make loan repayments. This indicates that your SMSF must always have cash available to satisfy the loan repayments in order to avoid defaulting on the loan. The self-managed super fund (SMSF) may be able to cover the cost of the loan repayments using either the income from the property's rental or the superannuation contributions that have been paid into the fund.
You don't need to have saved up the whole worth of that house in order to buy an investment property with your retirement savings or superannuation.
You can use the money in your retirement account as leverage to get a loan so that you can buy the investment property.
If you had a balance of $300,000 in your superannuation account, you could invest that money in a managed fund or in BHP shares worth $300,000; alternatively, you might use $200,000 of that money as a deposit and borrow an additional $400,000 to buy an apartment that costs $600,000.
There are a lot of limitations placed on how you can use your SMSF to take out loans.
To begin, you won't be able to make a full purchase of an investment property with your retirement savings or superannuation.
You have to keep some back as a buffer in case you need it. Because banks are now more cautious, they will only grant you a lower percentage of the property's value as a loan-to-value ratio.
You will only be permitted to borrow up to 70 percent of the value of the house from a financial institution at this time, and the institution will not permit you to take out lenders' mortgage insurance in order to boost that amount. Keep in mind, too, that the purchase of a property comes with a number of expenses that are not immediately obvious.
You are also required to maintain in your self-managed fund what is known as a "liquidity buffer," which must consist of things like cash and shares and must have a value equal to ten percent of the value of the planned investment.
Cash flow
Your self-managed super fund (SMSF) must make the loan repayments. To be able to make the required loan repayments, your fund must at all times have adequate liquidity or cash flow.
Hard to cancel
You are unable to get out of the arrangement if the paperwork and contract pertaining to the SMSF property loan are not put up correctly. It is possible that you will have to sell the home, which could result in significant losses for the SMSF.
Possible tax losses
You are unable to deduct the tax losses from the property from the taxable income you have earned outside of the fund. If you purchase a piece of real estate using an SMSF, the fund will be obligated to pay a tax rate of 15% on any rental income generated by the property. The fund is eligible for a one-third discount on any capital gain it generates upon the sale of properties that it has held for more than a year, reducing the fund's total potential tax payment on capital gains down to 10%.
If the property is acquired through the use of a loan, the fund is eligible to claim a tax deduction for the interest payments made on the loan. If you have more expenses than income, you will have a taxable loss. This loss will be carried forward from year to year and can be deducted from any future taxable income.
When trustees reach retirement age and begin receiving a pension, the fund will no longer be subject to taxes on any rental income or capital gains that occur.
You should also be aware that if you incur a loss on your property, you won't be able to deduct that loss from your personal taxable income if it comes from sources other than the fund.
There are to be no alterations made to the property
Until you have paid off the SMSF property loan, you won't be able to make any changes to the property that might cause it to take on a different personality. If the property was purchased by the SMSF with borrowed money, there are significant restrictions on the manner and type of modifications that can be made to the property while the borrowing remains in place. These restrictions apply both to the manner in which the property can be modified as well as the type of modifications that can be made.
Unsufficient Level of Diversity
Lack of diversification as a result of the sizable sum of money from an SMSF that could be required to buy a single direct property. It is necessary to have a portfolio that is well-diversified in order to generate income for retirement and to spread investment risk. This is done to ensure that a single asset class, such as real estate, does not dominate the risk and returns of your SMSF.
But there are a lot of other things to think about besides just diversification here. It is vital and a legal necessity that SMSF trustees assess the actual investment plan of their SMSF before making any decision regarding an investment. The strategy ought to include specifics regarding the amount of exposure that the fund ought to have to the property market, the sort of exposure, and an evaluation of how appropriate it is given the conditions that apply to the members of the SMSF.
The trustees of the SMSF are responsible for formulating an investment strategy, and that strategy must constantly account for the fund's investments. It is essential for trustees to have the proper understanding that this is not a problem that can be ignored. In point of fact, one of the responsibilities that auditors of an SMSF have on a yearly basis is to ensure that the SMSF in question does, in fact, have an investment strategy and that the SMSF's investments, throughout the course of the year, are in accordance with that strategy.
Associated Party Loan
A lot of people get help from outside sources in order to buy a house with their SMSF, and they do this by making a non-concessional contribution to their fund with the cash that they received.
The issue is that after you contribute money to the account, you will not be able to access those funds again until retirement, or even worse, you will not be able to contribute enough money within the parameters allowed. You are, however, able to lend the money to your retirement account, which enables the money to be withdrawn if the account is refinanced, and there is no upper limit to the amount that can be borrowed.
A common error that many people make when lending money is using a straightforward agreement for the loan. The limited recourse borrowing criteria of the legislation need to be satisfied by the loan agreement, and all terms and conditions need to be identified in a clear and concise manner.
Life Insurance
Life insurance premiums are tax-deductible in super.
It is a widespread misconception that this provision is still in effect even if the SMSF fund purchases a policy that will refund the debt in the event of the passing of a member. The answer is no.
In order for the premiums to continue to qualify as a tax deduction, they cannot be directly related to the explicit use of reducing the debt. It is conceivable for an insurance policy to successfully achieve the same result while also being tax-deductible provided that the SMSF and policy identification are properly worded.
Stamp Duty
It is necessary for the property to be moved from the holding trust into the SMSF once the debt has been paid down.
Stamp duty will often be assessed at the full property transfer rate in many states.
The first stamp duty trap can be avoided by using supplementary documentation at the time of the purchase, and the second trap can be avoided by doing the same.
Would you like to speak to a specialist? Book a complimentary discovery session by calling: (03)999 81940 or emailing team@klearpicture.com.au.
Consult with a professional
Before establishing a self-managed super fund (SMSF), individuals should, just as they should before making any other significant financial decision, seek the guidance of a registered financial planner in order to gain a comprehensive understanding of how their fund will function, as well as how they will be able to access and make use of their superannuation.