Buying Property through your SMSF

Self-managed superannuation funds (SMSFs) can be used to purchase both residential and commercial properties with or without a mortgage from a lender. If your SMSF has a sufficient balance for a deposit, then you are likely in a position to consider property investment as part of your SMSF investment portfolio.

Investing in property through your SMSF is not as straightforward as property investment without the support of your superannuation. Timing is important and having at least 5 to 15 years until retirement can ensure a steady flow of contributions to your SMSF after purchasing any property.

The Australian Taxation Office (ATO) offers guidance for any property asset bought through a SMSF and these points should constitute part of your investment strategy:

A) It is important that all investments are in the best interests of fund members and that the Sole Purpose Test is met. Your SMSF must have a sole purpose of providing retirement funds to its member/s.

B.) A property purchase must be made as an ‘arm’s length’ transaction and be maintained on a commercial basis; that is, not be used personally – for example, as a holiday home or leased to a family member.

To be deemed commercial, a SMSF-bought property must provide an income stream and have a realistic prospect of capital growth. Where one or more properties exists in a SMSF investment portfolio, you must consider:


• each member’s needs and circumstances (age and retirement needs)
• diversification (investing in a range of assets/asset classes)
• liquidity of the fund’s assets (how easily converted to cash to meet expenses)
• fund’s ability to pay benefits (when members retire)
• insurance to protect members and their retirement savings

C.) A property asset’s cost price, sale price and rental income must reflect true market rate of return and must not be bought by or sold to any member of your SMSF.

There are several pros and cons of holding a property asset in your SMSF portfolio:

Pros

• Combined investing: Where your personal savings outside of superannuation are not enough for a deposit amount, combining individual superannuation account balances with your partner or your family members may give you the purchasing power for a property asset for retirement investment purposes.

 

• Repayments from pre-tax dollars: If you can afford to save and have room within your concessional contribution limit, then you can salary sacrifice additional income to your SMSF to help pay off the property loan more quickly from your pre-tax dollars. Paying 15% on salary to make repayments is likely less than paying your marginal tax rate on your income and simply putting money in to a savings account.

 

• Tax-effectiveness: Superannuation receives concessional tax treatment on assets that are used to save for retirement. The earnings within your SMSF are taxed at 15% and there is a 33% discount for assets held for more than 12 months (that is, 10% CGT). This is most likely less that your marginal tax rate. An attractive bonus is a property held until retirement will result in the earnings within the pension phase being tax-free. This is in addition to any rent if you keep a property or the sale proceeds if you sell a property.

 

• Support your business’s growth: There are rules preventing you from purchasing a residential property for yourself or for a fund member. You may, however, buy a commercial/industrial property to lease back to your own business, potentially freeing up money to grow your business. Your business must pay a current and true market rate of rent.

Cons

• Fund set-up costs:Set-up expenses can seem prohibitive, but appraising mortgage fees and balancing costs against long-term benefits can make property investment achievable. The high cost means purchasing property through your SMSF is generally only suitable for funds with a balance of at least $250,000.

 

• Cash flow sensitive: You will need a larger deposit to purchase a property through your SMSF than if you borrowed directly. You may not borrow to build or to improve a property, so you will need to ensure that you can meet your repayments and property costs from rental income and any SMSF cash assets. Consider insurance for the term of the loan.

 

• Unsuitable for negative gearing: If you borrow to buy property through your SMSF and you are negatively geared, the tax offset only applies to other SMSF earnings – taxed at 15%.

 

• Large, illiquid asset: Your SMSF might not achieve diversification or have a lack of diversification if you have only one or two properties. It is wise to not have all your eggs in one basket, so reexamine your investment strategy by considering insurance, cash holdings and liquidity options to enable future pension payments.

 

• No personal benefit from property: Property investment within a SMSF must have been purchased as an ‘arm’s length’ transaction and must be maintained on a commercial basis. As such, a residential property may not be purchased from or leased to a related party. The ATO advises that one of the most common breaches of the sole purpose test is SMSF property assets providing pre-retirement benefits to fund members.

 

• Liquidity at retirement: When your superannuation transfers to the pension phase, you will need to ensure that you have accrued sufficient cash to make pension payments – without the risk of a possible fire sale of any property. Future pension payments currently range from 4% of a fund member’s balance before 65 to 5% from 65 – 75.

It is important to know that you, as trustee, are solely liable for the outcomes of your financial decisions for your SMSF. There is a risk that your investment strategy will not deliver the returns on investment that you planned or hoped, so it is highly advisable that you seek advice from a certified professional finance advisor.

How can YML help?

Talk to our YML Super Solutions Team today to see how YML Group can assist you with your SMSF. Contact us on (02) 8383 4400, or by visiting the Contact Us page on our website.