Self-Managed Superannuation Funds’(SMSFs) are a tax effective and efficient way of saving for your retirement. For many Australians, SMSFs are increasingly being used to purchase property. The advantages of a self-managed super fund depend on your circumstances, abilities, and inclination.

If you set up a self-managed super fund (SMSF), you’re in charge – you make the investment decisions for the fund, and you’re held responsible for complying with the super and tax laws. It’s a major financial decision and you need to have the time and skills to do it. An SMSF must be run for the sole purpose of providing retirement benefits for the members or their dependants.

Maintaining an SMSF requires extensive financial and legal knowledge which is why competent financial advice is needed. Before committing to an SMSF, it is important to understand the advantages and disadvantages of SMSFs.

Advantages of owning a property through a SMSF

There are a number of advantages to holding property inside an SMSF, as opposed to owning it in your own name.

Concessional tax on rental income

A concessional tax rate applies to superannuation investment earnings, rent received by your SMSF and you will be taxed at a maximum rate of 15%. Because certain expenses related to the ownership of the property such as land rates, property maintenance etc willgenerally be tax deductible to the fund.

Concessional tax on future capital gains

Special superannuation tax rates also apply to any capital gain made as a result of an increase in the property’s value. As a result, depending on when you decide to sell the property, any capital gain your fund makes on the sale of the property may be completely tax-free.

  • If you sell the property while still in the “accumulation” phase, the fund will generally pay CGT of up to 10% on any growth in the property value assuming that the property has been owned for at least 12 months)
  • On the other hand, if you decide to sell the property after you have transferred it into the “pension” phase, within your SMSF, any capital gain will be exempt from tax altogether

Using a LRBA to Purchase Property

Trustees of self-managed super funds (SMSFs) are generally prohibited from borrowing money, subject to limited exceptions under the super law. One of these exceptions is for limited recourse borrowing arrangements (LRBA). A LRBA involves an SMSF trustee taking out a loan from a third-party lender. The trustee then uses those funds to purchase a single asset (or collection of identical assets that have the same market value) to be held in a separate trust.

How to use a SMSF to purchase a property

There a few methods of purchasing a SMSF property:

  • Cash purchase
  • Tenants in common
  • Use of a 13.22c Trust
  • LRBA (borrowing funds using a Limited Resource Borrowing Arrangement)
  1. Cash Purchase

Purchasing a property with cash has benefits, including not having to pay monthly mortgage payments, and the costs and fees associated with the mortgage process. Not having to pay monthly interest is obviously the biggest benefit of this method.

  1. Tenants in Common

A TIC (Tenants in Common) arrangement is a type of ownership of real property by two or more parties. All tenants in common have an equal right to the property, even if their percentage of the interest is not equal or the living spaces are different sizes. There is no “right of survivorship”, if one of the tenants in common dies, each interest may be separately sold or willed to another (unlike a Joint Tenancy arrangement where the interest passes automatically to the survivor upon the death).

Example

A property valued at $500,000 is purchased by the SMSF and a related party who contributes $200,000 in their personal capacity.

How a SMSF and TIC arrangements operate

This method involves an arrangement between the SMSF and a related party to the SMSF (e.g., a member of the SMSF in their personal capacity). This strategy allows for other investors (including related parties) to participate in the transaction when the SMSF does not have sufficient capital to complete the deal on its own, or, where the investor is looking to take advantage of the concessional tax treatments available in superannuation for future income and capital gains (in particular in pension phase) on the SMSFs holding in the TIC. Percentage holdings are determined at purchase and are listed on the contract of sale and recorded on the title of the property.

Note: There are rules which apply to these arrangements and you should seek advise from your accountant. These rules refer to how the property is to be used, gearing and rules relating to trusts.

  1. Investing using a 13.22C Unit Trust to purchase a SMSF property

An alternative method of buying a property as tenants in common, would be to establish a Trust and each SMSF member can purchase units in a 13.22C Unit Trust, which acquires the $500,000 property. (see diagram below).

This method will overcome some of the restrictions associated with TIC arrangements such as those involved when acquiring a related parties’ interest, as well as borrowing restrictions.

How a 13.22C Unit Trust Operates

The 13.22C Unit Trust is a separate legal entity and will need its own ABN and TFN and will be required to lodge tax returns each year. The trust owns the property, can enter into the leases, receive rent and pay expenses. The net income is then distributed to the unit holders in accordance with their respective percentage holding in the trust. Although this ownership structure avoids some of the restrictions of a TIC arrangement, a 13.22C Unit Trust is subject to another set of strict rules that must be adhered to. Moving outside of these rules can result in the trust losing its 13.22C status and becoming a related party trust to your SMSF – raising serious concerns of non-compliance.

  1. Limited Recourse Borrowing Arrangements

A limited recourse loan is designed to enable you to borrow or gear your super into property and certain other assets, subject to strict conditions and certain limitations. This can enable the SMSF to acquire assets it currently doesn’t have enough money to purchase outright. Provided the governing rules allow for it, SMSFs can borrow to invest by using what’s called a ‘limited recourse borrowing arrangement’ (LRBA). To ‘limit the recourse’ of the lender, a separate property trust and trustee is established to hold the property on behalf of the super fund, outside the actual SMSF structure.

All the income and expenses of the property go through the super fund’s bank account. The super fund must meet all loan repayments. If the super fund fails to do this, the lender only has the property held in the separate trust as recourse and cannot access any remaining assets of the super fund. The diagram below gives a visual presentation of the structure of an SMSF property investment funded via a limited recourse loan.

Compliance rules applicable to LRBA – Talk to your accountant to clarify the following:

  • Value of SMSF Assets – SMSFs need to value all of their assets at market value, and the valuation needs to be based on objective and verifiable data
  • GST Registration – If the commercial property produces a gross rental income in excess of $75,000 per annum, the fund will also need to register for GST
  • Purchase the property in the correct name – The property must be purchased and held in the name of the trustee of the bare trust. Many people purchase the property first and then subsequently set up their SMSF and associated legal entities to arrange finance for settlement of the property. Failure to purchase the property in the correct name may lead to expensive stamp duty implications
  • Property Renovations – If you want to make an improvement to the property that is subject to a loan, the improvement must be funded from cash reserves held within the SMSF. Additionally, improvements cannot result in the asset becoming a ‘different asset,’ as the asset identified when the loan is put in place must continue to be the asset that is held on trust under the loan.

The methods described above set out the main ways you can buy a property with a SMSF. There are further rules relating to how to set a a SMSF which you need to chat to your accountant as the ATO has set out guidelines for establishing and operating SMSF’s.

Some common mistakes to avoid

We are often asked by clients to provide guidance on how to avoid the most common mistakes. We always recommend that at any stage of your property investment journey, you always seek appropriate advice.

  1. Do you have sufficient funds in your SMSF?

The costs of establishing and operating an SMSF with a balance of $250,000 or below are unlikely to be cost competitive, compared to alternative types of superannuation funds. You will also have to consider the time and skill required to manage your SMSF.

  1. Risking Non-compliance of the Fund

Where an SMSF trustee fails to maintain their fund in accordance with legal requirements, the ATO can impose several penalties. Where a penalty is applied, the trustee will generally be personally liable, and they will not be able to be indemnified out of the assets of the fund. A non-complying fund may be taxed up to 47% (includes 2% Medicare Levy).

  1. Do you understand the risks associated with gearing?

Gearing is where money is borrowed to finance the acquisition of an asset in the expectation that this asset will appreciate over time. Gearing may be used to accelerate the process of wealth creation by allowing an investor to make a larger investment than would otherwise, be possible. Conversely however, gearing will magnify any losses.

  1. No Debt Repayment/Exit strategy

Have your prepared a repayment and exit strategy for any borrowed funds. You should always borrow within your means (i.e. not over commit yourself). In relation to property investments within an SMSF, this consideration will include:

  • When you plan to sell the property
  • What loan structure you consider (e.g., interest only, fixed, or variable interest rate etc.)
  • The size, term of the loan and the repayment schedule
  1. 5. Will you have sufficient funds in the Retirement Phase?

When you decide to retire, your fund will be in the retirement phase and you will be relying on your fund to provide you with a pension There are strict rules requiring that set amounts must be paid out from the fund dependent upon your age, and the balance of the superannuation pension. Drawdown amounts can range from 4% per year if under age 65 to 14% at age 95. Trustees must ensure that funds will be available to meet drawdown demands.

  1. Not Adhering to Rules Governing Relationships with Related Parties

A significant proportion of mistakes made by SMSFs have to do with the blurring of lines between fund members and related parties. Three rules that are commonly breached are listed below:

  • SMSFs are prohibited from making loans to or providing any type of financial assistance to members or their associates
  • SMSFs are prohibited from holding in-house assets totalling more than 5% of the total value of the fund
  • SMSFs cannot acquire assets from fund members or other related parties to the fund except in the case of specified exemptions to this rule (listed securities, business real property and in-house assets that do not exceed 5% of the total market value of the fund)

Seeking financial advice is highly recommended to determine if an SMSF is appropriate for you and if purchasing direct property within this retirement vehicle is also appropriate. It is advisable that trustees spend a significant amount of time researc and planning their investment strategy.

How can we help?

If you have any questions or would like further information, please feel free to give our office on 08 9221 5522 or via email – info@camdenprofessionals.com.au  or arrange a time for a meeting so we can discuss your requirements in more detail.


General Advice Warning

The material on this page and on this website has been prepared for general information purposes only and not as specific advice to any particular person. Any advice contained on this page and on this website is General Advice and does not take into account any person’s particular investment objectives, financial situation and particular needs.

Before making an investment decision based on this advice you should consider, with or without the assistance of a securities adviser, whether it is appropriate to your particular investment needs, objectives and financial circumstances. In addition, the examples provided on this page and on this website are for illustrative purposes only.

Although every effort has been made to verify the accuracy of the information contained on this page and on this website, Camden Professionals, its officers, representatives, employees, and agents disclaim all liability [except for any liability which by law cannot be excluded), for any error, inaccuracy in, or omission from the information contained in this website or any loss or damage suffered by any person directly or indirectly through relying on this information.