Many people see property investment in a self-managed superannuation fund (SMSF) as one of the safest and most efficient ways to grow wealth and there are certainly many benefits to holding a property within an SMSF structure.
An SMSF is subject to demanding regulatory requirements however. For example, the rules for an SMSF investing in property are very complex and the consequences of getting it wrong can be very harsh. Therefore, it’s vital for the Trustee of an SMSF to fully understand the pros and cons of this structure as well as the restrictions involved when investing in property.
There is a restriction on the trustee of an SMSF acquiring assets from a related party of the SMSF but this exclusion does not apply to certain categories of assets. One that falls into the category is “business real property” of the related party, meaning that business is carried out on the property being acquired by the SMSF and provided it’s also being purchased at market value. The most popular types of property, typically residential property and vacant land are excluded. SMSF’s also have restrictions regarding who can use the property while it is owned by the SMSF even if purchased from an unrelated party.
One of the advantages of property investment within an SMSF is how income and Capital Gain is taxed. The net income generated from the rental property will normally have a concessional tax rate of only 15%. When the property is eventually sold and if there is a capital gain, the net gain is usually taxed at an effective rate of only 10%. On the other hand, the income or capital gain may be taxed at 0% if the property is being held by the SMSF to support the payment of pension benefits to a member of the SMSF.
Clearly, buying an eligible property and holding it long term can have solid benefits for an investor, but that’s not all.
An SMSF is allowed to borrow using a Limited Recourse Borrowing Arrangement (LRBA) to invest in property provided that the borrowing is used for the purchase of one single acquirable asset. The property is held in trust by another separate entity so that the SMSF has a beneficial interest in the asset and the rights of the lender to recover loan monies in the event of default are limited solely to that property. For this reason, the lender may often request guarantees from the individuals or, in the case of a corporate Trust, the Directors. This means is that the Bank has a right to call on the personal guarantor for any shortfall after disposal of the original asset.
The term, one single acquirable asset, is crucial in the context of the LRBA as it places restrictions of the type and number of properties that can be bought by the Trust using borrowed funds. In fact, the ATO has gone into some detail about what constitutes a single acquirable asset as well as what is meant by maintaining or repairing an asset as opposed to improving an asset.
When a SMSF uses an LRBA to purchase an asset, the arrangement must meet the following conditions:
- The SMSF must use the borrowed funds to purchase a single asset
- The SMSF can’t use the LRBA monies to ‘improve’ a purchased asset, although the borrowed money can be used to ‘repair’ or ‘maintain’ an asset. The practical implications of this distinction are one of the reasons why house and land purchases or construction of a dwelling are not available from Lenders under the SMSF structure.
- The SMSF trustees receive the beneficial interest in the asset although the legal ownership of the asset is held in trust usually by means of a Bare Trust.
- The SMSF trustees have the right to acquire the legal ownership of the asset.
These conditions generally mean that funding through the arrangements can be very complex and also impose significant restrictions on what can be done with the property during the life of the loan.
Although most of this article covers what the super rules permit you to do as an SMSF trustee, you also need to consider whether borrowing to invest is an appropriate investment, taking into consideration the risk and return of the underlying investment. Other factors that should be allowed for include the risk profile of the fund members, the cash flow considerations for the SMSF and whether the super fund is sufficiently diversified to meet its long-term investment objectives.
We strongly recommend you make an appointment with one of our SMSF qualified Financial Planners to shed some light on your ability to create wealth using an SMSF structure.
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