Buying Property with a SMSF?
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A Complete Guide to Buying Property with a Self-Managed Super Fund (SMSF)
Investing in property has always been a popular way to grow financial assets. But while property investment used to be the sole domain of the independently wealthy or the professional investor, a more diverse group of Australians are now getting involved. How are they achieving this? Many are using their retirement savings to buy investment properties through a self-managed super fund (SMSF).
But what exactly is an SMSF? What if you don’t have enough money in your superannuation to purchase an investment property outright? Are there set rules relating to SMSF property investment? And what are the benefits of buying an investment property through an SMSF? To help you find answers to all these questions (and more!), we’ve compiled a comprehensive guide to buying an investment property with an SMSF.
What is a Self-Managed Super Fund (SMSF)?
Put simply, an SMSF is a superannuation savings account that you manage yourself. While the majority of Australians still use a third-party super fund (such as Cbus, Hesta or Australian Super, to name just a few), self-managed super funds are starting to grow in popularity. According to the Australian Taxation Office (ATO), over 1.1 million people around the country now belong to self-managed super funds. Just as with a regular superannuation fund, monies held in an SMSF cannot be accessed until you reach the official ‘preservation’ or retirement age.
An SMSF can include up to four individual members, with all members listed as trustees to the fund. So, each member has an equal say in how the funds are managed and are equally responsible for compliance (including keeping detailed records, organising insurance and managing regular audits).
Having an SMSF allows you to control how your retirement savings are invested, while also providing certain tax benefits that aren’t available with third-party superannuation companies. While this may sound very appealing, it’s worth noting that SMSF’s come with a high level of responsibility to make sure everything is handled in the right way.
Can I use my SMSF to buy an investment property?
Yes, you can, and a growing number of people are choosing to invest their superannuation in this way. But before you head off to start hunting for an investment property to buy, there are some rules and restrictions that you’ll need to be aware of. Most importantly, self-managed super fund property investment must be carried out with the sole purpose of benefiting members after they retire.
What are the rules for buying an investment property through a Self-Managed Super Fund (SMSF)?
If you want to use an SMSF to purchase an investment property, then you’ll need to comply with the following regulations:
- Pass the ‘sole purpose test’, which stipulates that members can only benefit from the purchase once they reach retirement age.
- You cannot buy the investment property from anyone that you (or any of the trustees) are related to.
- None of the SMSF trustees or their families (known as ‘related parties’) can live in the house. The definition for ‘related parties’ doesn’t just apply to immediate family – no matter how distant the connection, they cannot live in the property if they are related to a trustee.
- The property cannot be rented by any of the trustees, their families or ‘related parties’. This also applies if the property is rented out as a short-term holiday home.
- You can’t transfer an investment property that you already own into the SMSF.
In light of these regulations, if you buy a residential investment property through an SMSF, your only real option is to rent it out to an unknown third party.
What costs are involved in buying an investment property through a Self-Managed Super Fund (SMSF)?
Just like with any type of property purchase, buying an investment property through an SMSF will involve some up-front and ongoing costs that you’ll need to consider. While funds from your super balance can be used to cover these expenses, you’ll want to make sure that the future income will replenish these costs, while also achieving fund growth. Typically, buying an investment property through an SMSF will involve the following expenses:
- Legal costs
- Stamp duty
- Upfront purchase costs
- Professional advice fees
- Bank fees
- Property management fees
Can I use personal funds to cover some of these costs?
Any trustee member can use personal funds to cover purchase costs, but it’s important to know this is viewed as a personal contribution to your superannuation. And, as a personal super contribution, you can’t just pay yourself back once the SMSF investment property starts generating income. So, no matter how much personal money you may invest in the purchase, you will not be able to recoup these funds until you reach retirement age.
Can I borrow money to buy a Self-Managed Super Fund (SMSF) investment property?
Self-managed super funds can borrow money to purchase an investment property. The most common way to do this is through a Limited Recourse Borrowing Arrangement (LRBA). With an LRBA, the self-managed super fund trustees can obtain a loan from a third-party lender. The money from the loan is used to purchase the investment property, but the ownership of the property is held in a separate trust. With this arrangement, any income generated from the investment property is deposited back into the SMSF bank account and all expenses for the property are paid out of the same account. But, if the SMSF were to default on the loan, the lender would only be able to seek recourse from the property held in trust. This ensures that any other assets held by the SMSF are protected in the event that a loan default does occur.
What are the borrowing criteria for a Self-Managed Super Fund (SMSF)?
Lenders generally have stricter borrowing criteria for an SMSF investment purchase (when compared with an average home loan). SMSF property investment loans may also have higher ongoing costs than a typical mortgage. Additionally, most lenders prefer the SMSF to have a balance of at least $200,000 before they will be willing to approve finance.
Specific lender criteria may vary, so if you’re considering setting up an SMSF with the goal of purchasing an investment property it is a good idea to talk to a mortgage broker first. Our experienced investment mortgage brokers will be able to provide more information on specific borrowing criteria that is applicable to your situation, as well as answering any other questions that you may have relating to LRBA and loans for SMSF’s.
What are the downsides to buying an investment property through a Self-Managed Super Fund (SMSF)?
Before you decide to buy an investment property through an SMSF, it’s important to evaluate all the potential pros and cons. The potential downsides of using an SMSF to buy your investment property include:
- Increased costs: Lenders will generally charge higher rates and fees for an SMSF property loan (when compared with an average home loan).
- Managing cash flow: Loan repayments will need to come from the SMSF bank account. This means you’ll need to ensure the fund always has a sufficient amount of money available to make the monthly repayments.
- Difficult to terminate: If there are any issues with your SMSF loan contract or documents (incorrect setup, etc.) then it can be difficult to resolve without having to first sell the property (which could result in your SMSF losing money).
- Tax constraints: With an SMSF investment property you won’t be able to use property tax losses to offset your personal taxation.
- Renovation restrictions: SMSF property loans have restrictions that apply to renovations on the investment. This means that your ability to renovate the property may be restricted until after the loan has been fully repaid.
What are the benefitsof buying an investment property through a Self-Managed Super Fund (SMSF)?
Despite the above factors, there are considerable advantages to buying an investment property through a self-managed super fund. These include:
- Reduced capital gains tax (CGT): Under Australian taxation law, any time you sell an asset (like real estate) you are required to pay capital gains tax. But with an SMSF investment property the CGT is capped at 10% should you decide to sell the property prior to retirement. If you sell the investment property after you’ve reached retirement age, then you won’t have to pay any CGT at all.
- Boosted retirement savings: With an SMSF investment property, your super fund may experience faster growth. This is because you’ll achieve capital growth as the property value increases, but you’ll also have additional contributions in the form of rental income.
- Ability to pay off SMSF faster: With a standard investment property, rental payments are used to pay down the mortgage. With an SMSF loan, repayments are made via rental income and routine super contributions, so the loan will be paid off much faster.
- Paying less tax on your contributions: SMSF’s are taxed at a rate of 15%, an amount that is much lower than the average tax rate for personal income. Additionally, interest paid towards your SMSF loan is tax-deductible for the SMSF.
- Retirement revenue: Once the SMSF loan has been repaid in full, the ongoing rental payments can be used as a reliable source of retirement revenue. Alternatively, the SMSF can choose to sell the property and then pay retirements revenue from the proceeds of the sale.
- Funding additional investment: An SMSF property investment can be used to fund additional investment in the future, thereby increasing the overall value of the SMSF.
Top tips for buying an investment property through a Self-Managed Super Fund (SMSF)
Ensure ATO compliance:
The ability to buy an investment property through an SMSF is governed by fairly strict regulations set out by the ATO. All trustees are responsible for ensuring compliance, so it’s important that all trustees are familiar with what can and can’t be done. Non-compliance can result in expensive penalties issued by the ATO, so it’s well worth taking the time to read up on applicable legislation.
Make sure the property is purchased under the right name:
If you want to buy an investment property through an SMSF then it’s realty important that the right name is used. It’s not uncommon for people to sign a contract before they’ve set up the SMSF and the related legal entities, assuming that they have until settlement to get things sorted. But if the property isn’t acquired under the correct name then you’ll end up having to pay stamp duty twice (once for the initial purchase and then again when you transfer it to the correct name).
Understand the restrictions surrounding renovations:
When you buy an investment property through an SMSF you are entitled to carry out routine repairs and maintenance. However, if you have obtained the property through an LRBA, you won’t be able to “make significant changes” to the property while the loan arrangement is still in place. Any extensive renovations would either need to wait until after the loan has been repaid or would require a new LRBA.
Get independent advice from experienced professionals:
Buying an investment property through a self-managed super fund is a significant purchase which requires plenty of planning and research. Before going ahead, you’ll need to determine what the future yield will be, what risks are involved and what kind of appreciation you’re likely to see in property value. To help you make informed decisions it is well worth speaking with experienced professionals who can offer impartial advice.
Coronis Finance in-house Financial Planning Services
A self-managed super fund can be a great opportunity for those looking to take control of their retirement investments. To find out more about what is involved in setting up and managing an SMSF, contact Coronis Finance today. In addition to providing loan solutions to SMSF property investors, Coronis Finance also offers in-house Financial Planning Services. We can talk you through the entire SMSF process, answer any questions that you may have regarding SMSF’s and even help with the initial setup and ongoing management of your self-managed super fund.