Holding more control and flexibility over your investment decisions is undoubtedly one of the key benefits of running a self-managed super fund (SMSF) over a traditional APRA-regulated fund. However, the benefits continue beyond there.
The flexibility of SMSFs extends to the type of investments that you can choose from. One of the most prominent and popular investment types that SMSF members are interested in is investment properties. These investment types come with their own strict rules, associated costs, and methods of management. So, it's crucial to understand the requirements around SMSF property investment to determine whether it is an in-house asset you are interested in.
Fortunately, we cover what you need to know about buying property with an SMSF, including how to follow the government rules and make the most of your investments.
Just as there are numerous rules and compliance obligations with running a self-managed superannuation fund, there are rules that must be adhered to when purchasing property through an SMSF.
Some of the most important rules around SMSF property ownership include:
The sole purpose test applies to all funds, from industry funds to self-managed super funds, and is managed by the Australian Taxation Office (ATO). The sole purpose test ensures that all SMSF trustees make decisions that are in the best interest of providing retirement benefits to its members.
In terms of purchasing property through an SMSF, important restrictions apply to ensure that the fund can comply with the sole purpose test:
Generally speaking, unless it's to repair the property back to the standard you purchased it in, you can only make alterations or improvements to the property once you've paid off the SMSF loan. Any other modifications must be funded using available cash within the SMSF.
Just like any investment, when you purchase investment property, there are certain risks you must overcome. SMSF property loans tend to come with the following risks when you choose to buy property as an investment:
You can't easily cancel the property agreement if you have made a mistake with the SMSF property loan documents or contract. In the case there is an issue with your investment property, you will likely have to sell it to get out of the agreement. This can negatively affect your SMSF in the long run.
Any investment through an SMSF requires a sufficient foundation of liquidity or cash flow to meet associated expenses. That is because there are multiple factors of an investment property that must be continuously paid off, including:
On top of this, your SMSF also requires liquified assets to cover costs associated with managing a super fund. This usually comes in the form of lump sum withdrawals or retirement pension expenses.
Compared to other property loans, either commercial or residential, SMSF property loan costs tend to be higher. This should be considered ahead of purchasing the property to ensure you can keep up with monthly repayments and interest rates.
Until the SMSF property loan is fully paid off, no alterations can be made to your property that will change its character. While necessary repairs are allowed, any additions or changes to improve property value aren't allowed.
You may face actual tax losses due to the inability to offset property losses against your taxable income outside of the super fund.
Loan repayments will still be required, even if you face a life-altering event such as a disability, illness, rental vacancy, or death of super fund members. Hence, you need to ensure a secure strategy is in place ahead of time to ensure repayments continue to go through in the face of such events.
Buying property with SMSF will come with unique costs that may differ from a usual property loan, or those associated with a private superannuation fund. Knowing these costs ahead of time will help you determine if an investment property is the best option for your retirement savings, and if you can keep up with the ongoing fees.
Common costs you will have to face include:
It can be beneficial to seek advice from a financial advisor to help keep on top of costs and to ensure your investment will offset them in the future.
Now that you know everything there's to know about the fundamentals of buying property with SMSF, it's time to learn how to get started. While it may initially seem intimidating to take on the challenge of buying a commercial or residential property with an SMSF, the actual process is fairly simple.
Just follow these steps:
Running a self-managed super fund comes with great responsibility in choosing an appropriate investment portfolio for the fund members. Not only do you have to consider investment diversification, but also what investments will suit your fund’s needs and requirements.
Thus, before you can deliberate on investment selection, the fund's investment strategy must first be determined.
Suppose you're thinking of adding a residential property or commercial property to the list of your fund's assets. In that case, you'll need to review your investment strategy to ensure that the property investment remains in line with the strategy. If not, an investment strategy update will need to take place.
Assessing the correlation between the intended property and the fund's remaining assets, as well as considering the resultant asset allocation and whether members are soon to switch into the pension phase, can all affect your decision to make a direct property purchase under your self-managed superannuation fund.
The ATO sets the compliance requirement that in order to borrow money for property investment, an SMSF must create a separate property trust through a limited recourse borrowing arrangement (LRBA). LRBAs are only offered by certain specialty lenders in Australia.
One of the key features of an LRBA is that the property is kept in a separate trust, so a lender only has a legal claim over the property. There is no further claim on your other superannuation assets if you default on the loan.
Part of the SMSF investment strategy review should be ensuring that your fund can meet liquidity requirements. Lenders of SMSF loans typically need at least 10% of the property value as liquid assets. For most funds, this means that after considering all property expenses, at least 10% of the fund must be left in cash assets.
Typically, lenders of limited recourse borrowing arrangements will offer a maximum loan-to-value ratio of 70% for SMSF borrowing. SMSFs need to ensure that they have sufficient funds to cover at least 30% of the property market value as a deposit, on top of covering other expenses such as legal fees, stamp duty and additional lender fees that cannot be built into the loan amount.
Like most other investments, there are tax implications when you buy a property in an SMSF. Naturally, one of the tax benefits of SMSF property ownership is that all the income is taxed at the superannuation tax rate of 15% (compared to when you buy residential property outside the superannuation environment, where it's taxed at your marginal tax rate).
One of the other potential tax benefits is that properties held for over 12 months can access a one-third discount on any capital gain, meaning that the capital gains tax liability is reduced down to 10%.
If the property is purchased through a loan (as most are), the interest payments are tax deductible against the rental income received. If the expenses exceed the income received, that taxable loss can be carried forward to offset future taxable income from the property.
Everything from loan repayments to property management costs must come from the SMSF bank account. Similarly, any rental income generated from the property must be paid directly into the SMSF bank account.
Many compliance differences exist between residential properties and commercial real estate when purchased through an SMSF. When looking at your potential income yield and capital growth potential, SMSF trustees should also consider the myriad of compliance requirements associated with both property types.
In the quest to curate a portfolio of the best SMSF investments, SMSF trustees often look to investment technology to assist in researching markets. HALO Technologies builds world-leading investment technology for all investors. Contact us today to learn how you can grow your retirement savings using HALO Technologies, or go ahead and book a demo to get started.
Only once your loan has been paid off can you live in your SMSF property. This can be done before or after retirement as soon as you remove the property from your SMSF.
You can sell property from your SMSF back to yourself so long as you ensure the transaction occurs at arm's length. This means all SMSF property sales should occur between two unrelated parties and the property itself should be independently valued.
Only then can you eventually obtain the property.
You can't rent a property owned by your SMSF. All rental agreements should be done between your SMSF and a third party, which excludes those related to you like parents, children, a spouse, or siblings. You can, however, rent out the property to unrelated friends.