Now that you have decided set up a SMSF, the correct structure for buying property can be explored further.
SMSF property investment using leveraged funds is regulated under the SIS Act. These superannuation regulations only apply when borrowing is used for a purchase. You could buy a property outright in the name of the SMSF if you had enough money sitting in the fund and the SMSF regulations would not apply. However, leveraging is a core investment principle and borrowing will be the means by which most people will be able to buy property.
This flow chart demonstrates how an SMSF fund conducts a property purchase using borrowed funds. It shows the relationship between the Self Managed Super Fund (SMSF) who contributes the deposit monies, the entity that provides the security for the loan (Bare Trust) and the Lender during a property transaction....
You can see that the purchase is made in their name of the Security Custodian/Bare Trust which provides a beneficial interest to the SMSF. The SMSF applies for the loan and the Lender takes out a Mortgage over the Property to satisfy their security position.
The owner of the property provides a Guarantee to the Bank, agreeing to the use of the property as security for the loan.
It’s interesting to note that the Lender only has recourse against the security property under Limited Resource Borrowing Arrangements in the case of default. This goes some way to explain why the credit policies for SMSF are so restrictive. Selling up a security property under an LRBA and being left with a potential shortfall would present a problem for any Lender. Their solution is to push the LVR down so any potential borrower has to contribute more with the added benefit of the property being almost self-servicing via the rent. The risk is reduced for both parties.
There are many considerations from a tax perspective when using Super to invest in property. Obviously you must be well informed of your taxation obligations to comply with the relevant ATO rules. Knowing these obligations will minimise any risk of breach.
As a SMSF trustee, you have a responsibility to make sure that the fund does not underpay tax or make any mistakes in its income tax return. We recommend speaking to a suitably qualified tax professional to make sure that you get your tax right, first time, every time.
The ATO is the official regulator for Self-Managed Superannuation Funds. They supervise SMSF compliance and contribute to superannuation and taxation laws. Given that a SMSF is essentially a trust taxation structure; the ATO is obviously best placed to handle all parts of SMSF compliance.
We should also recognize that the sole purpose of a fund is to provide retirement benefits, not save tax, so the current low tax rate is designed to encourage people to save for retirement. Without this encouragement people may decide to forgo superannuation and just rely on any applicable Government benefits.
Before retirement, members are usually working and their fund receives contributions from their employer. They accumulate funds until their retirement and in general, they can’t withdraw any money from the fund before then.
Currently, a SMSF pays 15% tax on its Normal Income, which includes:
- Managed fund distributions.
- Capital gains less than one year
- Concessional contributions from an employer.
- Deductible member contributions.
Long term Capital Gains, Special Income, Franking Credits and Foreign Tax Credits are all treated differently than Normal Income. Think of this as another reason why you should talk to a qualified tax professional about your Fund.
Avoiding double stamp duty
The last thing an adviser wants for a client entering into a SMSF loan, is for them to be slugged with a bill for double stamp duty. This is a real possibility if the process of acquiring the property and then transferring it into an SMSF is not conducted properly.
Avoiding double stamp duty depends on the way the property is put into the bare trust, also known as a Holding Trust, before it is ultimately transferred into the self-managed superannuation fund.
However, stamp duty law varies from state to state so there isn’t one single way to get a property into that Bare Trust.
What is essential is that the asset transfer process is strictly adhered to, making sure there is no question as to whether the Trustee really purchased the property for their SMSF. There should be no suggestion that they bought it on their own behalf and decided to put it into their SMSF later. Though the timing of the process varies from state to state, clients enter into the contract for sale in the name of the Trustee of the Bare Trust, making it very clear it is entered into at the super funds direction. This is an issue Financial Advisers work out for their clients in conjunction with a legal specialist in the SMSF area. Don’t think the Lender will bring this issue to your attention either. As far as they are concerned, Stamp duty is not their problem.
Capital Gains Tax (CGT)
Capital Gains Tax is a reasonable concern for property investors and the method of calculation can be confusing when the property is held inside a SMSF structure. Let’s create some clarity about CGT and an SMSF.
Your SMSF’s assessable income includes any net capital gains. Complying SMSFs are entitled to a CGT discount of one-third if the relevant asset had been owned for at least 12 months depending on whether the super account is in pension phase, or in accumulation phase.
Another way of describing ‘accumulation phase’ is simply to say when a super account is not in pension phase (that is, not paying an income stream/pension).
While a super account is in accumulation phase, any earnings on the assets representing that super account are subject to 15% earnings tax, although capital gains may be taxed at a discounted rate. Naturally, any capital gains that your superannuation fund makes from the sale of fund assets are subject to earnings tax. The tax implications when selling a SMSF asset, such as a property investment, will depend on the length of time a SMSF owns the asset before sale.
Therefore, during accumulation phase, if an asset is sold within 12 months of purchase, then any capital gains is subject to 15% earnings tax. More importantly, if the SMSF asset sold has been held for more than 12 months by the fund, then the fund can take advantage of the CGT discount. The discount means the SMSF only pays 15% earnings tax on two-thirds of the capital gain, which is basically, a capital gains tax rate of 10%.
If an individual is drawing a pension from a SMSF account, then no tax is payable on any earnings from assets financing the superannuation pension. This pension is known as an income stream.
In short, your super fund does not pay tax on investment income, including capital gains, from assets that finance a super pension.
This can potentially save you thousands of dollars in capital gains tax when compared to holding an asset outside super.