SELF MANAGED SUPER FUND
WHAT IS A SMSF?
Self-managed superannuation funds (SMSFs) do pretty much what they say on the tin: rather than paying super contributions into an industry fund or wrap, you pay it into a fund that you run yourself.
You choose what to invest in, and that can include direct property. All the running expenses of the property are paid by the fund, meaning you’re not out of pocket in the same way you would be with a directly-owned investment property, and your fund can take advantage of significant tax benefits.
Helen wants to buy a residential investment property using her SMSF. The purchase price is $500,000.
She has $250,000 in her accumulation account after making a post-tax contribution. Since she doesn’t have the full amount to buy the property, the SMSF trustees arrange to borrow $250,000.
Using the borrowed funds and the deposit paid by the SMSF trustee, the security trustee purchases the property. To get the finance needed, the security trustee grants NAB a mortgage over the acquired property.
The security trustee is the legal owner of the property. Once the loan is repaid in full the legal ownership of the property can be transferred from the security trustee to the SMSF trustee.
This case study is a hypothetical scenario and is intended for illustrative purposes only.
6 Simple Steps for Setting Up a SMSF
Draw up a trust deed
The process of creating a SMSF starts with preparing a trust deed for the fund. This will explain how trustees were appointed and what their powers are.
The deed must also set out when and how fund contributions and benefits will be paid. Most importantly, since the fund is being set up to invest in property, the trust deed must detail that property investing is allowed.
Create an investment strategy
The law requires trustees to have an investment strategy for their fund. Theoretically, this does not have to be in writing, but fund auditors often ask to see typed out hard copies.
The strategy should consider the risks and potential returns from different investments in the fund, the fund’s expected cash needs and its ability to meet any existing or future liabilities.
There should also be a mention of the makeup of the fund’s investments and the amount of diversification there will be.
The majority of SMSFs have two members, though single membership and funds with three or four members are not unheard of. Either way, a common place among SMSFs is that all members of the fund are trustees.
A trustee is legally responsible for the actions of the fund, which means he must log annual tax returns, prepare accounts and have the account audited.
Open a bank account
The last thing official step you need to take in setting up the SMSF is to create an account with a bank, credit union or building society.
To decide which account will work best for the fund, look at the fees and minimum balance requirements, as well as the interest rates on earnings.
At this stage, you will need to choose if the SMSF will be a regulated or non-regulated fund. Being regulated means the fund will be eligible for an array of tax benefits, foremost being that money coming into the fund will be taxed at a minimum rate of 15%. Making your choice is as simple as completing an application form, normally available at the Australian Business Register (abr.gov.au). After submitting the form you will be issued a tax file number for the fund and an Australian business number. Another point to consider is whether or not the fund will be subject to the Goods and Services Tax (GST). For SMSFs that source yearly income from commercial property that exceeds $75,000 a year, GST is mandatory. Registering is optional for all other funds.
Put money into the fund
Now that the fund has been started, you need to put money into it.
Transferring the existing money in your superannuation fund into the new SMSF account can take some time, but as soon as the money appears on the account balance, you can start buying property.
WHAT DO LENDERS LOOK FOR WHEN LENDING TO A SMSF?
Deposit: typically at least 30% of the property value;
Rental income: income expected from the property is factored into the borrower’s ability to make repayments;
Patterns of contribution: how frequently and consistently members make contributions to the SMSF as these will also be relied on to meet repayment obligations;
Structure of SMSF: must be compliant with ATO and ASIC rules;
How important are SMSFs in the world of tax-effective investing?
SMSFs are encouraging people to engage with their super in a way never achieved by industry and retail funds.
The tax benefits that come from holding investments in a super fund can contribute hundreds of thousands of dollars’ worth of capital gains to your retirement savings instead of handing it to the taxman.
REDUCE CAPITAL GAINS TAX TO BETWEEN 0% and 15%
Tax on SMSF earnings is capped at the same rate as other types of super fund (15%).
This means the maximum tax payable on the property’s income is 15%. Any expenses such as interest, council rates, insurance and maintenance can be claimed as tax deductions by the SMSF.
Capital gains tax is capped at 10% if a fund holds the property for more than 12 months and potentially no CGT bill will apply at all if the property is sold after you retire and your SMSF is in ‘pension phase’.
WHAT CAN'T I BUY?
Property for redevelopment and resale.
Property purchased for the purpose of redevelopment breaches the sole purpose test as may be interpreted as the fund carrying on a property development business or engaging in a one-off profit-making undertaking, rather than solely providing for members’ retirement.
An SMSF is generally not allowed to acquire assets from a member or an associate of a member. The word “associate” is very wide and includes many related parties.
A holiday home you intend to use or lend to a friend
Owning a holiday home you intend to use for private purposes (even one weekend a year) breaches the sole purpose test and in-house asset rule as you are now getting a current benefit from the asset and leasing an asset to a member or associate of the fund.
Although technically your SMSF can invest in all types of property including property located overseas, getting funding to do it is virtually impossible. According to Morgan you’ll be hard pressed to find Australian lenders who will finance an overseas investment or an overseas lender with the skills to navigate the complexities of Australian SMSFs.
DON'T HAVE ENOUGH SAVINGS IN SUPER?
If you’re looking for a way to buy a residential property but your super fund doesn’t have enough money, or you don’t want to go through an LRBA, there’s another option you can explore:
A Tenants In Common (TIC) arrangement would allow you to split the borrowing across your family home and your super fund.
For example, if the property you want to buy is $400,000, with a TIC, you could borrow $200,000 against your family home and use $200,000 from your super fund.
WHAT IS A LRBA?
SMSFs can buy assets such as shares and property by using cash in the fund and borrowing the rest. This can enable the SMSF to acquire assets it currently doesn’t have enough money to purchase outright. Provided the governing rules allow, SMSFs can borrow to invest by using what’s called a ‘limited recourse borrowing arrangement’ (LRBA).
With this arrangement, the asset is held during the life of the loan in a ‘security trust’ for the SMSF by a security trustee (which is a company other than the SMSF trustee).
If the SMSF defaults on the loan:
the lender’s rights against the SMSF are limited to the asset held in the security trust (i.e. other SMSF assets are not at risk), and;
the SMSF’s loss is limited to its beneficial interest in the asset and any repayments made before the default.
ADVANTAGES AND RISKS OF BORROWING WITHIN YOUR SMSF.
Possible advantages and disadvantages or risks of borrowing within your SMSF are dependent on your individual circumstances and investment arrangements.
The potential advantages may or may not apply to you, depending on things like: your SMSF’s cashflow (contributions or earnings), your level of experience in property investment, the diversity of your SMSF’s assets and your appetite for risk.
We strongly recommend that you obtain your own specialist financial, legal and tax advice (from advisers holding appropriate licences and authorisations to provide that advice) before entering into an LRBA via your SMSF.
If you are interested in using your superannuation fund to buy a long-term residential investment property, you may be unsure of where to start.
Midas Property Solutions can assist you with every stage of your SMSF property investment – get in touch with us today to discuss your options.
The above information is provided for general education purposes only and does not constitute specialist advice. It should not be relied upon for the purposes of entering into any legal or financial commitments. Specific investment advice should be obtained from a suitably qualified professional before adopting any investment strategy.