Australians don’t necessarily love or understand superannuation or the stock market but they have a love affair with property. Which is why many of us are using the negative-gearing rules to our advantage and building up property outside superannuation as part of our retirement plan.
What more and more people are realising is that you can now borrow to buy property through your self-managed super fund (SMSF), which means suddenly super is attractive once more.
It’s important to understand that you can’t just sell all your property to your SMSF, sit back and start benefiting. SMSFs have different, far stricter rules, regulations and restrictions to borrowing in either your own name or another entity. So what are the rules you need to be aware of and the pros and cons for borrowing property in your SMSF? I’m so glad you asked. SMSF property rules
Monica, from the TV show Friends, once said rules are there to make the game more fun but that’s not necessarily the case when it comes to property and SMSF. If you breach a rule the consequences are expensive and potentially irreversible, so it’s important to know what they are and to follow them to the letter.
The most important rules to understand when it comes to property and SMSF are:
- The property must not be acquired from a related party of a member (unless it’s commercial property).
- The property must not be lived in by a fund member or any fund members’ related parties.
- The property must not be rented by a fund member or any fund members’ related parties (but a related business can rent a commercial property).
The exception is with business premises, as a related business owner can sell to and/or rent a commercial property owned by an SMSF.
This means your SMSF can potentially buy your business premises, allowing you to pay rent directly to your SMSF at the market rate. It’s often an attractive option and one of the most common ways to own property in an SMSF.
SMSF borrowing rules
An SMSF is allowed to borrow to acquire property if, once again, specific and strict criteria are met. What’s important to understand is that banks are becoming more and more stringent with both the criteria they are following and the size of the deposit required.
That’s if they’re willing to lend to an SMSF at all. Some of the borrowing rules include:
- The property must be held in a bare trust whose trustee must be different to the SMSF trustee. A bare trust is a trust where the title holder holds the property for a specified beneficial owner (in this case the SMSF trustee).
- Each borrowing arrangement must only be used to buy a single asset, for example a residential or commercial property.
- The borrowing must be non-recourse, which means the lender cannot go after any other fund assets other than the property that was bought with the funds borrowed.
Once you understand the rules it’s still important to weigh up the positives and negatives of following this particular strategy. And there are quite a few of both. The main negatives when it comes to SMSF and property are:
- Higher Costs SMSF Property loans tend to be more costly than other property loans (unless you are borrowing personally and on-lending to the SMSF).
- Cash Flow Loan repayments must be made from your SMSF, which means your fund must always have sufficient funds to meet the loan repayments.
- Hard to Cancel If your SMSF property loan documentation and contract is not set up properly, unwinding the arrangement may not be allowed, which means the property must be sold.
- Can’t borrow to improve the property Borrowed funds can be used to maintain a property but can’t be used to improve a property.
- Lower LVRs (loan valuation ratios) If borrowing directly from a bank, there are lower LVRs that banks will use, which is typically 70-80 per cent for residential and 60-70 per cent for commercial properties, so a bigger initial deposit is required.
- Arrangements must be commercial If your business is renting commercial premises owned by your SMSF and you are unable to pay rent, you may need to evict yourself in order to remain a complying fund.
- Equity not available You can’t use the equity in one property as a deposit for another property or to reach LVRs, as each property must stand on their own.
While the main advantages for holding property in an SMSF are:
- More money into super All Australians are limited by the amount of contributions they can make into super but particularly by buying your business property in the fund, there is the opportunity to contribute more to super through rents paid.
- Capital gains free asset This is one of the biggest and most attractive advantages. If a property is sold by an SMSF after fund members have retired, then all profits made on the sale of the property are CGT free.
- Rents are tax free If a property is kept by an SMSF after fund members have retired, then all profits made on the rental of the property are tax free and monies drawn by the member of the fund as income are also tax free.
- Lower income tax rate If properties bought in the fund are positively geared, the profits are taxed at the fund’s income tax rate, which is a maximum of 15 per cent (or 30 per cent for high-income earners).
Still interested? Make sure you don’t just rush in but instead talk to an accountant or planner who is a licensed SMSF specialist before making any decisions.
A great accountant will be able to financially model for you the best place to hold your property so you can make an informed decision as to whether SMSF and property are right for you. Melissa Browne is an accountant, adviser, author and shoe addict.