If you’re dead set on investing in property through your SMSF make sure you know what you could be in for, writes Richard Livingston

Residential property investing through an SMSF is a fertile ground for deception. Type the words ‘SMSF property misleading’ into your Google search bar and you’ll find pages of articles and notices about ASIC fines, investigations and actions against financial advisers, property promoters and assorted spruikers.

If you’re going to play in this space it’s important that you understand the rules, what needs to go right and what could potentially go wrong.

Keep in mind that investing in residential property through an SMSF can be a pain in the neck and wallet, compared with buying the property in your own name. In addition to the usual hassles – bad tenants, unexpected bills and strata fights – there’s an additional layer of rules around what you can and can’t do.

Members of the SMSF can’t use the property, nor can they lease it to family members. Employing related “tradies” can lead to unintentional breaches of the SIS Act (the governing legislation for super funds) by the SMSF trustees.

If the SMSF is borrowing, you’ll need to set up a costly limited recourse borrowing arrangement and ensure you don’t spend borrowed money on items the Australian Tax Office might classify as improvements. Properties on multiples titles and property development can also cause SMSF trustees to breach the SIS Act.

For the most part, SMSF property investing is all negatives. So why do people do it?

The answer is tax. A super fund only pays 15 per cent tax on its ordinary income and 10 per cent on capital gains. If the fund is in pension mode, it pays no tax at all. This means if you make a bundle, the taxman sees very little (or none) of it.

But you need to be confident that the profit and tax benefit will ultimately be worth it. Your financial adviser may show you a nice looking set of numbers but that’s of little help if reality doesn’t follow suit.

If you’re able to buy an SMSF investment property without borrowing, your main worry is whether it’s a good investment. But if you’re borrowing – especially if you’re borrowing a large part of the purchase price – the success of your “SMSF punt” hinges on two key factors: the capital growth rate of the property and the future for SMSF loans.

When you’re borrowing to invest in property, the interest on the loan typically offsets the rental income or if it’s greater, creates a “negative gearing” deduction. As a result, in the early stage of the investment there’s little benefit in using an SMSF, and if it’s negatively geared, you may be worse off than if you bought the property in your own name.

In these cases, whether you get an overall tax benefit from investing through an SMSF will depend entirely on the capital growth achieved. You’ll save a lot of tax if you make a big profit on sale, but if you’re borrowing a large amount and achieve low (or no) capital growth, you may find the pain and hassle of investing through an SMSF was pointless.

SMSF property investing may also be a bad option if differential pricing on property loans becomes the norm, or if SMSF lenders withdraw from the market altogether.

AMP recently announced it was increasing the interest rate on investment property loans by 0.47 per cent. If you have the ability to draw down on your home mortgage to buy an investment property, then by using an SMSF you’d be paying half a per cent extra every year you have the loan.

The trend towards differential pricing could in the future see SMSF loans charged an even higher rate. It’s a grim scenario, and one that could become worse if lenders start exiting the SMSF lending business altogether.

National Australia Bank stopped writing SMSF property loans earlier this year and as regulators tighten capital requirements or the market slows, other lenders may decide to follow suit. Remember, SMSF loans aren’t as “locked in” as regular home loans. They typically include “review events” that allow the lender to reassess (and potentially terminate) the loan for things as simple as the fund switching into pension phase.

Imagine going through the hassles of an SMSF property investment only to find you’re paying a higher interest rate down the track or your loan is pulled, forcing you to sell the property?

Of course, in addition to whether you achieve enough capital growth or the SMSF loan market changes, you’ve got the politicians to worry about. The budget can only cope with so many forest fires at once, and down the track we could see higher taxes on capital gains or super generally.

Borrowing within an SMSF to invest in property is a bet on strong capital growth and no adverse changes to the SMSF loan market or super rules. Make sure you understand this reality, and the consequences – before you start out.

Richard Livingston is a founder of Eviser.

This article contains general investment advice only (under AFSL 469838).

Posted by Richard Livingstone – Money (The Age) on 25th August, 2015