Using a self-managed super fund to acquire a property has become a popular strategy with investors. But there’s a right way and a wrong way to do this and it’s important to know the difference between the two or risk substantial penalties.
Kane Munro, a director of online accountancy and bookkeeping firm Accountancy Online, says in terms of the considerations investors should be making if they are thinking about putting a property in their SMSF, the first one is whether this strategy will improve retirement outcomes.
“The point of any investment is to maximise your investment returns. This is even more important when it comes to superannuation. Ultimately your investment choices will dictate whether you can potentially lead a fairly comfortable retirement or have to rely on government support,” says Monroe.
He notes an enabler of property in superannuation was the change of rules in 2007 to allow for borrowing inside superannuation, as this has put property within reach of many self-managed superannuation funds. “But just because you can doesn’t always mean you should and it is important to see property as part of your portfolio and not your entire portfolio.”
When the changes were introduced in 2007, limited recourse borrowing arrangements were introduced as the way for superfund’s to access loans to purchase a property.
“Effectively the LRBA means that the lender only has right of recovery against that asset and not other assets of the funds,” says Brad Callaughan, a director of Callaughan Partners.
To establish an LRBA you first have to have the correct structure. “This normally involves a trustee company as trustee for the super fund along with another trustee company as trustee for a special purpose trust, also known as a bare trust. This was set up to allow the bare trust to hold the asset in trust for the beneficial owner, the super fund,” he explains.
NEED 20 PER CENT DEPOSIT
The property needs to be purchased in the name of the trustee for the bare trust. The loan is taken out in the name of the super fund.
Says Callaughan: “The super fund uses its funds to pay for the deposit for the property and legal expenses, collects the rent and pays all the expenses for the property.”
He notes that before committing to any borrowing arrangement inside your SMSF, it is always wise to speak to a lender to discuss your borrowing power.
“In simple terms you will require a 20 per cent deposit, plus enough money to cover stamp duty and legal expenses within the super fund, or ready to roll over from another super fund.”
The fund’s potential to borrow money is based on members’ super contributions and the rental income from the property.
“If you already have an SMSF and your trust deed is old, you might need to have it updated to allow for it to purchase property,” Callaughan advises.
In terms of the risks and rewards of using an SMSF to invest in a property, Munro says a positively geared property in an area where real estate is enjoying good capital growth can be an excellent wealth builder in a superannuation fund.
“Rent received by your SMSF will be taxed at a maximum rate of 15 per cent and any capital gain is generally subject to tax at a discounted rate, or is entirely tax free if sold in pension phase.”
In terms of risks, Munro stresses it’s worth remembering superannuation and property is a tricky area. “If you don’t know what you are doing there are some pretty heavy penalties if you get it wrong. So make sure you find a good accountant or professional adviser who knows what they are doing.”
UNDERSTAND THE RULES
Another downside to property in a super fund is that having a large, illiquid asset in your fund like property can involve some cash flow management to ensure there is enough free cash on hand so the fund can pay its day-to-day expenses. If the fund is in pension phase, and the property is the fund’s only asset, it may not be able to pay an adequate retirement income for members.
Greg Einfeld, director of SMSF experts Lime Super, agrees it’s important to understand the rules.
“If the fund is unable to meet its repayments then the bank can repossess the property, but cannot touch other assets of the SMSF,” says Einfeld. As a result banks often require a personal guarantee from the trustees of the SMSF.
He says once the property has been purchased using debt, any improvements must be paid for by cash in the fund, as opposed to paying for these expenses using further borrowings. The improvements also can’t change the nature of the property.
“The most common mistakes SMSF members make when buying property arise from not getting the documentation correct. This includes having the wrong names on the property contract or loan contract, and buying the property before all the required entities have been established,” Einfeld advises.
Another common mistake is having insufficient cash in the fund. “If the property is vacant for a period, or if the member isn’t receiving contributions, then the SMSF won’t be able to meet its obligations,” he notes.
Finally, with banks getting tougher on lending, some trustees are finding they have agreed to buy a property but cannot get finance.
Says Einfeld: “It is always a good idea to get the finance in place before committing to buy property.”