Buying Property Through Your Super - SMSF
Updated: Feb 7, 2020
For many years people have been using their SMSF to purchase property. Since the change in legislation in 2007 which allowed SMSF’s to borrow funds in order to purchase assets, coupled with more detailed terms of borrowing to purchase residential property, this strategy has become increasingly popular.
Investing in property using your superannuation is not for everyone. It is suggested that an individual research this strategy thoroughly and grasp their own situation before making a decision. Typically this strategy would be most suitable for those aged between 30 and 50 as they still have a decade or two before they retire. This allows them to continue to make contributions to their super and if they hold on to the property until after retirement they will be able to make full use of the tax concessions associated with this strategy.
Up to four individuals are permitted to combine their superannuation accounts into a SMSF and then use the SMSF to purchase residential or commercial property. They can make this purchase with or without the financial support of a mortgage from a lender.
When purchasing a property through the SMSF the investment needs to be in the best interests of the funds members. The fund will follow the legislation put in place for this type of investment strategy as well as meet the “Sole Purpose Test”.
It is important to consider the age and financial situation of each fund member.
The SMSF will also need to consider:
Diversification – Ensuring the SMSF is investing in a mix of different assets and asset classes
The liquidity of the Assets – If the assets can be converted into cash easily
If the fund will be able to pay the benefits to its members at retirement and other costs that may arise
Members demographics and circumstance in order to meet the needs of each member
Ensure that there is a strategy put in place to protect the members retirement savings
Guidelines that the ATO have proposed when using this strategy include:
Investments must be purchased on an ‘arm’s length’ basis and must be maintained on a strict commercial basis.
The investment must meet the sole purpose test of providing retirement benefits to fund members.
Based on the above guidelines the purchase cost, rental income and sale price of the property must be a true market rate of return. This means that the residential property cannot be bought from a party associated with any of the fund’s members this is known as a “related party transaction”.
Property investment in superannuation may be beneficial for some. In particular the instance where an individual’s personal savings as well as their balance within their superfund is not enough to meet the deposit requirements of purchasing a property outright. In this situation pooling your superannuation balance with your family members’ balances will allow the group to have the purchasing power to invest in a large asset.
Tax-Effective. The income in your SMSF is taxed at a rate of 15%. If the asset has been held for more than 12 months, the SMSF will only need to pay capital gains tax of up to 10% if the property is sold. If the investment property is held until the members retire, the earnings within the pension phase may be tax free, subject to the transfer balance cap which is $1.6m currently.
Beneficial for your business. Although the rules do not permit the purchase of a residential property from a related party whether it be a business associate, yourself or a relative you are however permitted to have a “business real property”. A business real property is classified as a property that is wholly being used for business purposes. In this instance the superfund can invest in a business real property and lease it to the fund members own business. It is important to note that if you do so then you will need to pay a current market rate of rent.
A tangible investment that can be value-added. Both a residential and commercial property investment has the potential to be “value added”. Whether this be a renovation of the existing infrastructure or an extension. Investors like to have control over their investments and like to see those investments grow.
The lack of Diversification in your SMSF. One downside to highlight is that it is hard to have a diverse range of investments in your SMSF if you have used the funds to purchase one or two large assets.
Higher set up costs. The set up costs associated with purchasing an investment property through a SMSF can run into the thousands of dollars and in some cases lenders may charge higher fees for obtaining a loan. It is important that SMSF members consider the set up costs against the long term benefits.
A fund member cannot personally benefit from the investment property. The property is purchased on the terms of a strict commercial basis. A common cause of breaching SMSF legislation is when a related party transaction has taken place. A common example of this would be a fund member using the investment property as a holiday house. It is important to note that a residential property cannot be purchased from, sold to or leased to any related party.
The fund members need to be certain that there will be a consistent future cash flow. You may borrow funds from the SMSF to invest in a property however you cannot borrow further funds to renovate, refurbish or build on the property. Therefore the fund members need to be certain that the rental income from the property and their contributions into the fund will be sufficient to cover any costs that may arise in cash form.
As investing in a property through a SMSF will use a large portion of the fund’s cash it is essential that the fund members ensure they have enough cash in the fund upon retirement. There needs to be enough cash within the fund to be able to meet the pension payments for the fund members. If the fund lacks the appropriate amount of cash it may in turn lead to a “fire sale” of the investment property.
For further advice please contact our office on 02 9299 7044 to be referred to a licensed advisor.