With the current boom in the Australian property market, it is becoming increasingly common to purchase property with superannuation. The key to enabling you to do this is having a Self Managed Super Fund, commonly referred to as a SMSF.
A SMSF is a private superannuation fund that you are in complete control of – you choose where your money is invested. A SMSF can have up to four members. Commonly, a SMSF may be set up by a married couple looking to pool their superannuation and use it to invest.
The members of the fund still receive the benefit of their investment as they would if they had industry or retail superannuation fund. However, instead of investing in shares or managed funds, you may be investing directly in property, where the value of the fund is contributed to by rental payments and the value of the property, which will appreciate over time.
A SMSF is a key to investing directly in property with superannuation and comes with several favorable tax benefits and the potential for significant capital gains. Although this all sounds like a great idea, you must be aware of the relevant restrictions and requirements related to SMSF property purchases before choosing this option.
It is important to remember the purpose of superannuation – to be there for you when you eventually retire. Superannuation is a long-term form of savings that is strictly regulated in relation to how you can invest it. This may weigh heavily on how and where you choose to invest.
This article sets out some of the key considerations related to SMSF property purchases.
Setting up a self managed super fund
Setting up a SMSF is a necessary part of the process when investing your superannuation in a property. This fund is different from the industry or retail super funds, as you have more control over what happens with your money. The fund itself comes with setup fees which vary depending on the complexity of the fund but generally range from $1,500 to $3,000. There are also annual administration costs and investment fees which must be factored into the decision of whether to use a SMSF.
Generally, it is important to ensure your existing superannuation balance is reasonable before making the switch. A common recommendation is that a minimum of $200,000 is needed to make the fund worthwhile, with balances over $500,000 realising more competitive returns when compared to APRA-regulated funds.
It is important to seek the advice of a financial advisor or accountant when deciding whether the benefits of a SMSF will be valuable to you, given your specific financial circumstances.
At an arms length
One key restriction to consider is that SMSF investments must be kept at an arms-length at all times. Therefore, you cannot purchase property from a related party such as a parent. Furthermore, if the property is residential, you and your family cannot live in the property if it is owned by the SMSF. The rules and regulations surrounding SMSF investments and related parties are strict. For this reason, it is highly encouraged that a legal representative is involved in the process.
Whilst many people choose to invest in residential property, it is also worth considering whether purchasing a commercial property using a SMSF might be a better option for you. Where a residential property is generally limited to a small number of tenants and therefore, sources of rent, commercial property has the potential to provide for many more sources of rent if, for example, the property is a multi-story office building.
Even if you only have one tenant, generally the amount of rent paid in a commercial property is greater than that of a residential property. Weighing against these benefits is the higher price that is likely required to purchase a commercial property. This becomes an issue if you need to borrow money.
Borrowing to assist your SMSF purchase
To enable you to invest in property using your SMSF, you may be considering getting a loan to assist with the purchase. However, given the strict regulations on superannuation, there is a general prohibition on SMSFs borrowing money. This does not mean it is impossible, but it is certainly less straightforward than borrowing for an individual. The difficulty that comes with borrowing in a SMSF may mean that if you wanted to purchase property you would need to have the full purchase price plus legal fees, stamp duty and other related costs immediately available.
For a SMSF to borrow money, the best approach is to engage in a limited recourse borrowing arrangement. Limited recourse borrowing is the main exception to the general prohibition on SMSFs borrowing money. The process involves a trustee (member of the fund) obtaining a loan, which is then used to purchase an asset (let’s say a commercial property). This asset is held in a separate bare trust to limit the SMSF’s liability in the event of default. As with all loans, the trustee must consider the terms of the loan itself and balance this against the viability of the investment.
Limited recourse borrowing can be a difficult process to understand, so it is recommended that you seek the advice of a legal practitioner as soon as possible to get you off on the right track.
Make sure the paperwork is correct
It is critical to get the documentation right for any SMSF transaction. Transactions involving SMSFs can be extremely complicated and require significant care and attention to detail. The best way to ensure any SMSF transaction is completed correctly is by seeking the advice of an experienced law firm who deals with complex commercial and residential transactions on a day-to-day basis. This will ensure that the framework for your investment strategy is set up correctly and that you are well informed of your responsibilities and obligations.
Assessing the long-term tax benefits
To be eligible for tax concessions the SMSF’s sole purpose must be to provide retirement benefits to the members of the fund. When considering what the purpose of your fund is, it is important to consider the use of assets and arrangements with related entities.
There are potential long-term tax benefits involved when investing with your SMSF. Capital gains tax on a SMSF investment held for longer than 12 months is capped at 10%. If you convert your superannuation into a pension, you are exempt from capital gains tax altogether. Therefore, the longer you hold the investment the better. You could potentially save hundreds of thousands of dollars by waiting to sell the purchased property until the fund members are in the pension phase.
The prospect of future tax benefits should influence what type of property you purchase. It is tempting to buy a property based on its good price in today’s market, however, a small saving in the short-term may not necessarily be beneficial 10-20 years down the track. When choosing a property to invest in it’s important to consider how it will age financially. Will it deliver good income and financial growth in the long term? Is it in a good location, perhaps a growing community with the potential to expand?
Investing with your SMSF is a great way to have control over where your super is going and how your financial future takes shape. A SMSF provides increased independence through the greater control conferred on the members of the fund. The members can choose from a wider variety of investments when compared to retail or industry superannuation funds, which may include residential or commercial property.
These options provide a significant opportunity for a high return on investment, however, come with a large deal of responsibility and risk. Choosing the right property, at the right time and executing the paperwork correctly can be instrumental in facilitating the success of your investment.
At Burgess Thomson, we recommend consulting with a lawyer at the very beginning of your SMSF investment journey. It is wise to have the support of a legal professional throughout the entire process to avoid any potential pitfalls. Burgess Thomson has legal specialists in SMSF property purchases and can assist with every step of the transaction.
My name is James Thomson and I widely recognised as a leading lawyer in New South Wales with over 20 years of experience working in local law firms in Newcastle, top-tier law firms in Sydney, and international law firms in London.