FIND OUT THE ADVANTAGES, DISADVANTAGES AND BORROWING CONDITIONS ON PROPERTY
Buying property as an SMSF investment is a common choice for trustees, as it’s the only superannuation option that allows you to invest in property directly, rather than investing in managed funds or trusts. As an SMSF trustee, you can purchase an investment property on behalf of your SMSF. This means the fund has control of the asset, including receiving rental income and paying to maintain the property. The rental lease is between the tenant and the SMSF, not you or any other member of the SMSF personally.
If you are looking to buy property through your SMSF, there are a number of rules that apply. The property must meet the sole purpose test, which means it must be purchased solely to provide retirement benefits to members. It can’t be acquired from a related party of a member, or be lived in or rented by a member or a related party of any member.
The one exception is property that is classified as business real property, which is property that is occupied and used wholly and exclusively as a business premises by one or more businesses. The SMSF can purchase business real property from a member or related party and place the rent directly into the SMSF, as long as it’s on an arm’s length basis, which means the rent must be paid at full market value and on commercial terms.
Your SMSF can also invest in property indirectly, through unlisted property trusts or Real Estate Investment Trusts (REIT). This option can offer a more diversified property portfolio for SMSFs that don’t have significant funds to invest.
ADVANTAGES OF INVESTING IN PROPERTY
Investing in property through your SMSF can offer a number of advantages.
Generally, investment earnings from assets that are purchased to support a pension are tax-free.
This means that once you retire and start receiving a pension from your SMSF, you pay no tax on rental income and do not pay Capital Gains Tax (CGT) if you decide to sell the property. Before retirement, your SMSF will only pay up to 15 percent on rental income and CGT. If you borrow to invest in property, the loan is paid off using rental income and member contributions. Other assets in the SMSF are secure, as the lender can only claim the investment property if you default on your loan.
You can also enjoy tax deductions available to landlords, including expenses associated with the property and depreciation on assets like fittings and fixtures. If you purchase real business property and use the premises for your own business, the rent you pay will also contribute to your retirement savings. Property is a reasonably secure, long-term investment that can give you peace of mind for your retirement. It’s a visible asset that’s easy to manage and can offer diversification in your portfolio.
DISADVANTAGES OF INVESTING IN PROPERTY
One of the main disadvantages of owning property in an SMSF is that members can’t access the investment or rental income until they reach retirement or have satisfied another condition of release. For this reason, it’s a better investment for those who can afford to invest in property and hold onto the asset until after they reach the pension phase, when they will be exempt from paying tax. For residential property, there are restrictions on who can use the property. Members and their friends or family members can’t live in or rent the property at any time, regardless of how much rent they are willing to pay. If you have borrowed funds to invest in property, you can only make repairs to maintain the property and not renovate or improve the asset in any way until after the loan is paid off.
Loans to SMSFs are subject to much stricter regulations than regular mortgages, so it can be more difficult and expensive to finance property in an SMSF. If the property is negatively geared, the tax offset only applies to other income earned within the fund, not your regular income outside of the SMSF. You also need to consider the costs associated with purchasing and maintaining a property. Property involves high set-up costs and you will need to be prepared to cover loan repayments and ongoing maintenance costs, or provide a lump sum benefit in the event of a members’ death. Other risks include the value of the property, which may rise or fall over time, as well as cash flow pressure on the SMSF if the property remains vacant for a period of time. Appropriate insurance and thoughtful planning can reduce many of the risks associated with property investment. Talk to your SF Wealth financial adviser to find out more.
TRANSFERRING PROPERTY INTO YOUR SMSF
There are two ways you can transfer property into your SMSF—by personally contributing the property to the fund or by selling the property to the fund. Transferring property that is owned by you, another member or a related party into your SMSF can only occur if the property is classified as business real property. This means it must be occupied and used wholly and exclusively by one or more businesses—no part of the property must be used for any other purpose, no matter how small. If you are looking to personally contribute the property to the fund, you need to be aware of non-concessional (after-tax) contributions limits, which are currently a maximum of $450,000 every three years. If the property is worth more than $450,000, you will only be allowed to transfer part of the property to your SMSF. The balance will need to be purchased by the fund at full market value, with the money going directly to you or your existing mortgage.
Your SMSF can borrow funds to purchase the property, which may help you avoid this situation. Costs associated with transferring property into an SMSF include State Transfer Duty fees, Capital Gains Tax (CGT) and costs for legal and professional services. These costs can be significant, so it’s important to work out if the property is an appropriate investment for your SMSF and aligns with your investment strategy.
SMSF BORROWING CONDITIONS
Borrowing to invest in property can only be done under very strict conditions, known as a Limited Recourse Borrowing Arrangement (LRBA). Under these conditions, you can only purchase a single asset or the collection of identical assets that have the same market value. The property will be held in a separate trust until the loan is paid and SMSF trustees receive any investment returns earned by the asset during this time. If you default on the loan, the lender’s rights are limited to the asset held in the trust, so the remaining assets held in your SMSF are protected. Once your SMSF has paid off the loan, you can move the property out of the holding trust and acquire legal ownership of the asset. Investing in property through an SMSF requires expert advice. Talk to your SF Wealth financial adviser to find out the best way to incorporate direct and indirect property into your investment portfolio. This information is general in nature and does not take into consideration your personal circumstances.
Talk to your SF Wealth financial adviser for SMSF advice that’s right for you.
