When it comes to managing your super, residential and commercial properties are two of the most popular assets to invest in, accounting for $35.7 million and $67.9 million respectively in allocated assets as of June 2018.
But what makes investment property so appealing to SMSF members? Increased capital and lending power are two major reasons.
How so? Well, an SMSF is allowed to have up to four individual members. This means, each trustee can pool their money and assets together, and use their combined resources to purchase higher value properties. Secondly, the borrowing rules for SMSF’s have relaxed considerably over the past decade, making it easier for trustees to get the extra money they need to buy investment properties.
Of course, while an SMSF investment property can be incredibly profitable, there are strict rules you need to follow, and not everyone is up to the task to manage and invest their own super.
To help you decide whether using SMSF to invest in property is right for you, here’s a few handy tips.
How to invest in property using SMSF
When you set up an SMSF, you have the freedom to invest in both residential and commercial property if you comply with the following rules:
- The investment property must be held in your SMSF’s name, while all income and expenses must go directly to and from this account.
- Either you, your trustees, nor anyone associated with you or your trustees, are allowed to live in the investment property. The property must be leased out to the public at standard rental market rates, no discounts allowed.
- You’re not allowed to transfer an existing investment property, whether it be residential or commercial, into your SMSF account.
- When using an SMSF to purchase a commercial investment property, the rent you pay must be at current market rates, and the investment must still satisfy the goal of the SMSF – provide retirement benefits for all members.
Upfront and associated costs
Just like a standard property investment, you can expect to pay a range of fees – including stamp duty, legal fees, bank and settlement fees, and estate agent fees.
However, there are some fees unique to an SMSF property investment.
For instance, if you plan to borrow money through an SMSF, you need to create a separate trust (more on this later). This’ll cost anywhere from $500 to $2,000 in documentation and accounting fees. Furthermore, interest rates are typically higher for SMSF loans compared to standard property loans.
Now, you may be wondering, “Can I deposit my personal finances into the SMSF, fund the purchase, and then withdraw the funds after?” This practice is strictly prohibited, as you’re only allowed to withdraw money from an SMSF once you’re old enough to start a pension.
How to borrow for an SMSF property investment
In order to borrow money for an SMSF, you must enter what’s called an LRBA (Limited Recourse Borrowing Arrangement).
This is when an SMSF trustee takes out a loan with a third-party lender, uses those funds to purchase a single asset (or a collection of identical assets that are equal in value), and puts the asset into a separate trust.
Any money you earn from an investment property – i.e. rental income, or super contributions – must go straight to your SMSF.
If you default on your loan, your rights as a lender will be limited on the asset held in the separate trust. This means, a lender can only take recourse on assets held in that separate trust, not the SMSF itself.
Here are a few other borrowing rules that are unique to SMSF’s:
- Loan repayments must come from your SMSF, so earning a steady, consistent income is incredibly important
- You cannot make alterations to the property until the SMSF loan is paid off. However, you can still use the borrowed funds to perform minor repairs and maintenance.
- Some LRBA’s can be difficult to cancel. Carefully review the terms of your LRBA, and have it checked by a legal expert before you sign anything.
Buying an investment property through SMSF is one of the most effective ways to reduce your tax liabilities – especially when it comes to tax on rental income.
When you buy an investment property in your own name, you pay up to 45 percent in income tax. Under a company, the maximum income tax is around 30 percent. And when purchased through an SMSF? The maximum you pay is a concessional tax rate of 15 percent.
On top of this, buying a property through SMSF will also greatly lower your capital gains tax – the tax you pay on the profit of a property sale
While these are a tremendous savings, your SMSF must meet strict criteria to be considered a ‘complying SMSF’ by the ATO. By talking to an SMSF specialist, they can show you how to become a complying super fund and reap the massive tax benefits.