SMSF and Property
Buying properties through an SMSF should comply with rules set by the government. The SMSF property must:
- Meet the sole purpose test which is to provide retirement benefits to the members of the fund
- Was not acquired from a related party of a member
- Not be lived by any member or trustee or by any related parties.
- Not be rented by a fund member or any related parties.
However, the SMSF can potentially buy your business premises and allow you to pay rent directly to the fund at current market values.
What are the costs involved in purchasing properties?
There are many fees and charges involved in sales or purchase of an SMSF property. When added up, they can potentially reduce your super balance. These fees include upfront fees, legal fees, advice fees, stamp duty, bank fees and ongoing property management fees.
To get good advice regarding investments on a property, be reminded that SMSF advisers that you deal with should be licensed by the Australian Financial Services (AFS).
SMSF has strict borrowing conditions called ‘limited recourse borrowing arrangement’. This arrangement can be used in purchasing a single asset like a residential or commercial property. Before investing on a property, as a trustee or member, the investment should be assessed if it is consistent with the investment strategy and risk profile of the fund.
SMSF property risks include:
Higher costs. SMSF property loans are more costly than other property loans.
Cash flow. Repayment of loans must be made from your SMSF. This requires that your fund must always have enough cash to meet the loan payments.
Hard to cancel. If the SMSF property loan contract and documentation were not correctly made, unwinding the arrangement is not allowed or possible. Since this is the case, you might be required to sell the property which may cause losses to the fund.
Possible tax losses. Tax losses from the property are not allowed to be offset against a member’s taxable income outside the fund.
No alterations to the property. Alterations to the SMSF property that changes its character cannot be made until the loan is paid off.
Before making investments to properties, make sure that you research about them first before investing.
SMSF Property Investment
As a member or trustee of an SMSF you have to make sure that the property investment will have an income stream and encourage capital growth. The investment strategy of an SMSF should take the personal circumstances of the members, their age and risk tolerance into account and should consider:
- Diversifying investments in various assets and asset classes
- Ensuring the liquidity of the fund’s assets. SMSF should have easily convertible assets to meet fund expenses
- The ability of the fund to pay benefits when members retire and regular costs incurred in its operation
- The needs and circumstances of a member like their age and retirement needs
- Steps to take to ensure and protect the retirement savings of the members.
According to ATO, when purchasing an asset through an SMSF, the investment should be purchased at an ‘arm’s length’ basis and should be maintained on a strictly commercial basis. It should also meet the sole purpose test of providing retirement benefits to the members and trustees of the fund when they retire.
Therefore, taking these advices from ATO means that the purchase cost and sale price of the property must reflect the true market value of the investment. It also means that you cannot buy a property from or sell a property to a related party or people who are associated with the members of the fund. It also means that you cannot receive personal benefits from holding the asset.
Pros and Cons of Holding a Property in an SMSF
Investing as a couple or family. Combining the account balances with other members of your family will give you the purchasing power to invest in large assets.
Tax-effective. Superannuation gets a concessional tax handling of assets that are conserved to save for retirement. Earnings from the superannuation are taxed at only 15% with 33% discount for assets held for more than 12 months. This is most likely less than the marginal tax rate. Earnings from the property in the pension phase are tax-free. This could be in the form of rent or sale proceeds if you decide to sell it.
Make repayments from pre-tax. You can opt to salary sacrifice more income to pay the loan faster from pre-tax. You only have to pay 15% on salary sacrifice and make additional repayments than pay the marginal tax rate on income and save it outside the super.
Support Business growth. SMSF rules do not allow the purchase of residential property for yourself or a related party. It is, however, allowed to buy commercial or industrial properties to lease back to your own business as long as you pay the current market value of the rent. This technique frees funds up and grows the business.
More control over your investments. Given the authority and power to control the investments of the fund is one of the main attractions of SMSF. Value is added to SMSF property investments through renovation or development. SMSF members are given the real facts on where their money is going.
Big illiquid assets. Lack of diversification in an SMSF may not be in the best interest of the members. Look into insurance, cash buffers and funding for future pensions for retiring members.
Higher set up costs. Setting up an SMSF is costly. Getting loans through the SMSF may also include higher lending fees. Therefore, you need to balance these costs against the long term benefits of the strategy. Buying property is also only suitable for funds that have $200,000 or more.
Not good for gearing negatively. When you borrow money to buy a property through an SMSF, tax offset applies only to other income earned by the fund at a 15% rate and not at marginal tax rate on your regular income.
Personal benefit from the SMSF property is not allowed. One of the most common breaches of the sole purpose test according to ATO is that assets provide pre-retirement benefits to members or their associates. The common breach that members do is using the SMSF property as their personal holiday house or rent the property to a family member. SMSF residential properties cannot be purchased from, leased to and rented to related parties of members.
Cash should be certain. The level of contributions and rental income from the property should be enough to pay for costs incurred from the operation. You can borrow money to buy properties but cannot borrow to improve the property. Consider having an income protection insurance and life and TPD insurance for the loan’s term. Cash buffer is very important for an SMSF.
Retirement and Liquidity. When members reach the pension phase, the fund should ensure that there is a sufficient amount of cash to fund the pension payments. The cash required should be at least 4% of the member’s pension balance before 65 and 5% from 65 to 75 and greater from here.
Reduced personal borrowing capacity. Banks usually ask for personal guarantees, restricting SMSF members’ personal borrowing power.
If you want to find out more about SMSF property investments or if you want advice from an approved SMSF auditor Melbourne, talk to us.
Kingston Knight Audit are the Auditor Melbourne experts to contact when dealing with your trust account audit, SMSF Audit, financial statement audit, and internal audit requirements. Contact us today, Kingston & Knight Audit offers a free telephone consultation to establish how we can best help you achieve the assurance and compliance you require.