A growing number of Australians are showing interest in self-managed super fund rules. Based on the latest information released by the Australian Taxation Office (ATO), there were 593,000 self-managed super funds (SMSF) in Australia in June 2020. This represents a 3% increase from the preceding year and a 15% increase from the 2015-2016 ATO report. These self-managed super funds boast over 1.1 million Australian members, with a combined value of $676 billion worth of SMSF investment. And as more people aim to take control of their retirement reserves, we’ve seen more people buying property with super.
While an SMSF may seem like a straightforward way to grow your retirement savings, self-managed super funds have unique rules. Buying property with an SMSF is very different to buying through an investment company or a family trust, so the SMSF rules can sometimes come as a surprise to even seasoned property investors. To ensure you protect your self-managed super fund assets, it’s important to have a clear understanding of what SMSF investment property rules apply.
Buying Property with Super
Before we begin, let’s clear up exactly what a self-managed super fund is. An SMSF is a superannuation fund that you manage yourself (it’s all in the name really!). Currently, most Australians are members of a third-party superannuation fund. When you first started working, your employer may have signed you up with a retail superannuation fund (usually run by an investment company or a bank) or an industry super fund (such as HESTA or Cbus). Your employer would then make regular contributions, on your behalf, into your superannuation account. Your super fund uses this money to invest and (hopefully) grow your retirement savings.
You can be the sole member of a self-managed super fund, or there can be up to four individual members. You’ll still make regular contributions, and the funds won’t be accessible until you reach retirement age. The big difference with a self-managed super fund is that you control how the money is invested. And with record-low interest rates and a booming property market, more people are buying property with an SMSF as a long-term investment.
Understanding Self-Managed Super Fund Rules
Self-managed super fund rules place specific restrictions on how assets can be invested. While these rules may seem needlessly restrictive (at first), they’re designed to protect members from high-risk investments. It’s important to clearly understand all the applicable self-managed super fund rules because non-compliance can result in tough penalties. And when it comes to SMSF rules, the ATO will hold all members equally accountable (even if a member was unaware of the rule in question).
Some of the most important SMSF investment rules (that you may or may not be aware of) include:
1. The ‘sole purpose test’
Perhaps the biggest SMSF rule you need to know about is the ‘sole purpose test’. This is because every decision that your SMSF makes needs to comply with the sole purpose test. Essentially, your SMSF must be for the ‘sole purpose’ of building retirement savings for its members. If the fund made an investment that would deliver benefits to any members before they reached retirement age, this would fail the sole purpose test. And once the fund fails the sole purpose test, the ATO will tax it at the highest marginal rate, in addition to levies.
2. Buying assets from members
Another SMSF investment rule relates to buying assets from members. An SMSF cannot purchase any assets that belong to members or related parties (such as immediate family members). There are no exceptions to this rule for residential property purchases (even if the agreed price is listed at the true market value). Exclusions to this rule can apply to commercial property or share purchases, but it’s best to consult with a tax professional to ensure compliance.
3. Personal use of assets
One of the SMSF rules that often catches people out is that members can’t use SMSF assets for any personal reasons. So, if an SMSF invests in a holiday rental property, the members and their extended families will not be able to book the property for a holiday (even if they’re renting it out at full price). As with the above rule, there are some exemptions. One notable exception is for commercial properties. These can be leased by members (or the relatives of members), so long as a proper commercial lease is in place.
4. No lending of funds
Self-managed super funds have rules that prohibit lending, with limited exceptions. While this might not seem like a big deal at first glance (most SMSF members aren’t planning to lend their retirement savings to someone else), this rule can correlate to buying property with super. For example, you may have been planning to contribute personal funds towards an SMSF investment property purchase. But if you then planned to reimburse yourself from the fund in the future, the ATO would classify this as a form of “lending”.
5. Kept at ‘arms-length’
The ATO requires that all SMSF dealings be conducted on an ‘arms-length basis.’ Essentially, this means that all transactions must show the true market value (with all personal feelings on the matter set aside). Any income that your investment property generates must be set at market value, and any assets that are bought or sold must also be at true market value.
SMSF Investment Property Rules – The Need for an Investment Strategy
SMSF investment property rules also stipulate that each fund must have a formal investment strategy in place. This plan needs to address the following four key elements:
- The estimated return and risk of any potential investment.
- How the fund will diversify its investments across a variety of assets.
- What the SMSF’s investment goals are.
- How the fund will maintain liquidity to pay out member benefits, routine expenses and any applicable taxes.
This investment strategy will be assessed during routine audits, so SMSF members must comply with all the stated objectives. The strategy should also be routinely reviewed and, if necessary, updated to reflect any changes.
Buying Property with an SMSF – Your Investment Options
- A residential property that is leased to a tenant.
- A holiday rental property that is rented out for short or long-term stays.
- A commercial property (such as a factory, shop or warehouse), that is subject to a commercial lease.
All of these investment property options are available to self-managed super fund trustees. This is provided the purchase meets the sole purpose test, is bought at market value and won’t be used by any of the members for personal benefit.
Self-Managed Super Fund Investment Rules – Borrowing and Lending Criteria
There are some borrowing and lending criteria to keep in mind when it comes to purchasing an SMSF investment property. These include:
SMSF investment rules allow for assets to be purchased using borrowed funds from a third-party lender. Usually, this is achieved through a Limited Recourse Borrowing Arrangement (LRBA), which is designed to protect the SMSF if they default on the loan repayments. Under an LRBA, the self-managed super fund members apply for a loan and use the borrowed funds to finalise a property purchase. At this point, the ownership of the property is transferred to a separate trust. Any income that the investment property generates (through rental monies, etc.) will be deposited into the SMSF account. The loan (and any other property expenses) will be paid out of the same account. But if the SMSF were to default on the mortgage, the lender would only be able to claim against the investment property held in trust. The lender would have no legal right to claim other assets held by the SMSF.
Lenders will often have specific criteria that they apply to SMSF investment loans. While criteria will vary between lenders, common restrictions include having a minimum SMSF account balance (usually at least $200,000). A loan for an SMSF property purchase will also typically attract higher operating charges when compared to a traditional residential home loan.
SMSF members can use their own personal funds when purchasing a self-managed super fund investment property. However, this will be classified as a ‘personal contribution’, not a loan. You won’t be able to pay yourself back once the sale has been finalised and the property is generating income. This means that you won’t receive any ‘personal contributions’ back until you’ve reached retirement age and you obtain your superannuation payout.
Getting Started with Self-Managed Super Fund Property Investment
If you’re considering a self-managed super fund investment solution, contact the experienced team at Coronis Finance today. Our expert team of finance brokers can answer all of your questions and help you to find the SMSF loan that’s ideal for your circumstances. You can also make an appointment to speak with our in-house Coronis Financial Planning Services team for more advice on self-managed super fund management.