Before investing in property using a SMSF, it is important to know that there are significant rules and regulations in place as to how that property can be used.
Investing in residential property
Any residential property owned by a SMSF is not able to be leased to anyone who is a member of the fund, or a relative or business partner of a member, all of whom are considered to be a ‘related party’ of the fund.
Residential property purchased by a SMSF cannot be lived in by any trustee, or anyone related to a trustee, for any period of time. Likewise, a trustee or anyone related to a trustee cannot rent the property. This therefore precludes a SMSF being used to purchase a second home or holiday property, for instance.
Furthermore, your SMSF is not permitted to purchase or receive via transfer from you a residential property that you already own.
Investing in commercial property
As long as it is being used solely for business purposes, a commercial property purchased through a SMSF can be leased to a business owned/operated by a member of the fund, provided it is done at arm’s length, with all rents being at market rate and paid on time.
Unlike residential property, a commercial property owned by a member can be contributed to a SMSF, provided the transaction is at market value and is subject to contribution caps. The transfer may also be subject to stamp duty, capital gains and tax.
In order to purchase a commercial property using a SMSF, a specific type of loan is required. This will have stricter criteria than other types of loan, particularly with regard to loan to value ratio (LVR).
Using a SMSF to purchase a commercial property can be a potentially useful investment strategy for small business owners, as it means they can own the premises out of which their business operates. However, it must at all times satisfy what is known as the sole purpose test, i.e. the prime function of a SMSF is to provide retirement benefits to its members (or to their dependants if a member dies before retirement).
Tax liabilities when purchasing property through a SMSF
The fund will be required to pay 15% tax on any rental income derived from the property. Once a property has been held for twelve months, capital gain tax liability is reduced to 10% if the property is subsequently sold.
If the gross rental income froma commercial property is in excess of $75,000 per annum, the fund will need to register for GST, 100% of which can be claimed for expenses associated with theproperty.
The interest payments on any property purchased with a loan are tax deductible to the fund. If there is a taxable loss on the property (i.e., expenses associated with owning the property exceed the income derived), this can be carried forward each year and offset on future taxable income (however, losses cannot be offset against personal taxable income derived from outside the fund).
Once the fund’s trustees retire and start receiving a pension, rental income or capital gains arising in the fund are tax free.