The Guide To Buying Property Through An SMSF
Property investment through a self-managed super fund (SMSF) has become increasingly popular in recent years, particularly ever since SMSFs were able to borrow money to fund direct property purchases. This is an area where you have to be sure you know what you are getting into. Our guide to buying property through your SMSF can be found here.
Investing in residential properties
A property bought through an SMSF cannot be occupied by you, another trustee or anyone related to the trustees, no matter how distant the relationship. You, the other trustees, and anyone related to them are not allowed to rent it. It is not allowed to buy a holiday home in your SMSF and live there during the summer. Additionally, you cannot transfer an existing residential investment property you have into an SMSF, whether the fund purchases it at market value or contributes to it within the cap.
Commercial property investment
Generally, investing in commercial properties through an SMSF has some advantages over residential properties. In SMSFs, it is very clear that residential property cannot be rented out or occupied by you or any other trustee. The property cannot also be rented or occupied by any relatives of the trustees. Investors who think they can buy a holiday house in their SMSF and enjoy it over the summer need to think again; the rules are clear and strict.
Commercial and residential properties, however, can be sold to an SMSF by its members, as well as leased to SMSF trustees of similarly situated individuals or businesses, but it is still important to consider the implications. SMSF trustees can own commercial properties, not just small businesses. An SMSF may apply for a specific SMSF loan to purchase a commercial property.
The SMSF criteria, however, are stricter than traditional lending with a lower debt-to-value ratio. Many small business owners use SMSFs to purchase business premises and then pay rent directly to the SMSF. Rent for your business premises must be paid at the market rate (no discounts) and must be paid promptly and in full at each due date. This must also satisfy the SMSF's overarching purpose, which is to provide retirement benefits for its members (this is called the sole purpose test).
However, to comply with the regulations you must ensure that the purchase provides a retirement benefit for the trustees. Take into account the yield and anticipated growth in property value. If the property does not meet your expectations, you may need to reconsider.
Tax consequences of buying, renting, and owning real estate
SMSFs are required to pay 15% tax on the rental income they receive from properties they buy through SMSFs. Any capital gains the fund may make upon selling a property held for more than 12 months are subject to a one third discount.
If the property is purchased by a loan, the fund can deduct the interest payments. When trustees begin receiving pensions at retirement, any rental income or capital gains arising in the fund will be tax free. Note that if you make a loss on your property, any tax losses cannot be offset against your personal taxable income outside of the fund.
Dos and Don'ts for Commercial Products
Rent is often considered to be dead money. The fact that commercial property purchased through an SMSF can be leased back to the trustees makes sense considering many take advantage of paying off their asset and not a landlord's. SMSF funds have the option of investing 100% in commercial premises if a member runs a business. For small businesses that wish to own the premises from which they operate, this can be an attractive proposition.
An investor or business that owns a commercial property can contribute the property to the SMSF. The transaction must be at market value and subject to contribution caps. It is important to know that transferring property can result in capital gains, stamp duty, and tax implications, so get advice before making concrete plans.
When it comes to leasing the property to a related party, it must be done on the same terms as it would with an independent third party. You need to have a lease arrangement in place with an independent third party, outlining clearly the terms and conditions of a standard commercial agreement. A market rate rent will need to be paid regularly and physically into the SMSF bank, and the property will need to be assessed periodically.
Borrowing to buy property in your SMSF
A limited recourse borrowing agreement (LRBA) allows an SMSF to borrow money to purchase property. To 'limit the recourse' of the lender, a separate property trust and trustee is set up outside the SMSF structure to hold the property for the SMSF. The super fund's bank account is used for all income and expenses of the property. All loan repayments must be made by the super fund.In the event the super fund fails to do this, the lender has recourse to only the property held in the separate trust and cannot access any remaining assets of the super fund.
Guidelines for SMSF borrowing
An SMSF's borrowing criteria are generally much stricter than a traditional property loan you might obtain as an individual.Loans also come with higher costs, which need to be considered when deciding whether to invest. Currently, most financial institutions will not lend to an SMSF unless the fund holds a balance of at least $200,000.
If your primary reason for wanting an SMSF is to purchase property, then consulting with a bank or mortgage broker is strongly recommended before you even establish your fund.You must therefore have sufficient funds in your SMSF to cover the loan repayments. The SMSF can fund the loan repayments from the rental income on the property and from contributions into the fund.
Complying with the requirements
The assets of SMSFs should be valued at market value, and the valuation should be based on objective and verifiable data.If the SMSF owns commercial property, an independent valuation will need to be provided by a real estate agent or registered valuer. If the commercial property generates a gross rental income of more than $75,000 per annum, the SMSF will need to register for GST.
If the SMSF is GST registered, it can claim 100% of GST on any expenses associated with the commercial property. Once the property begins to generate income, it will be taxed at 15%. In the event that the property is sold (after having owned it for more than 12 months), capital gains tax will apply. If a member's SMSF is in pension phase and the sale falls within the member's $1.6m balance cap, then no capital gains tax is due.
From a tax planning and long-term capital growth perspective, commercial property continues to make an attractive case for small business owners. There is, however, a flip side to every investment. When choosing commercial property for your SMSF, factors such as lack of investment diversification and liquidity considerations should be considered.
Compliance is your responsibility
The ability to borrow money to purchase property in a SMSF comes with some very strict rules and obligations that you may not be aware of since these are not requirements that apply outside an SMSF. Many trustees don't become aware of these rules until an audit is performed on the fund.
The ATO will hold you responsible if you don't know what you can and can't do as a trustee. Not getting it right can come with expensive repercussions, from trustee penalties issued by the ATO to stamp duty implications. Every trustee is personally liable for the fund's decisions, even if another member/trustee makes them. As a result, it is important to engage experienced, qualified specialists to help you manage your own retirement savings.
Purchase the property under the correct name
The property must be purchased and held in the name of the trustee of the bare trust. Many people purchase the property first and then subsequently set up their SMSF and associated legal entities to arrange finance for settlement of the property. Failure to purchase the property in the correct name may lead to expensive stamp duty implications.
Borrowing money to pay for simple maintenance and repairs to a property can be an option. It is allowed to make significant improvements or renovations to the property, but the funds must come from available funds within the super fund, not from a loan or borrowed money.
The original asset that was purchased with limited recourse borrowing cannot be significantly changed. In the case of renovations that substantially alter the asset, a new limited recourse borrowing agreement will be required.
A single acquisition asset
When it comes to acquiring an asset, the concept of a single acquirable asset is key. The basic premise is if the property runs over multiple title search title will require its own bare trust, trustee and LRBA.
The ATO has clarified certain scenarios that it is permissible to have just one LRBA and where multiple LRBAs would be required.
Single LRBA is required in these scenarios:
A factory that runs over multiple titles and therefore cannot be sold separately
If a cash deposit is made, an LRBA can be used to pay the remaining balance
Apartment with separate car parking space - separate titles cannot be separated, so one LRBA must be used
Option to buy a house (just the option) - if the house then is purchased, this must occur under a separate agreement.
Multiple LRBAs required in these scenarios:
If the vendor will only sell the two titles together (but it is legally permissible to sell them separately)
Farmland with multiple titles – if no legal impediment to selling them separately
A block of land purchased – later it is decided a house is to be built on block
A serviced apartment that is fully furnished – the apartment and furniture are seen as two separate assets.
Purchasing a property: fees and charges
As a result, there can be substantial fees and charges associated with the purchase, ownership, and subsequent sale of a property in an SMSF. These will eat into your super balance so you need to ensure the income in the super fund will cover these costs and allow for growth.
It is common for people to assume that if they contribute personal money to purchase, that once the super fund has the money, they can repay themselves. You may contribute your own money to help purchase the property, but this is considered a personal contribution to your super fund and cannot be withdrawn until you meet preservation age.
A self-managed super fund SMSF can give you more control over your retirement and superannuation, depending on your financial situation. With strict governance and complicated rules, those looking at investing in commercial property through their SMSF, SMSFs should always consider the following: advice from qualified and experienced professionals.
We can provide you with SMSF solutions through Accountants360. We can provide you with SMSF solutions. We provide SMSF setup, management, and maintenance services.