What is a SMSF?
A Self Managed Super Fund (SMSF) is a form of trust that is designed to provide a retirement income for its members, who are also its trustees. Members of the fund direct their superannuation contributions into the SMSF account.
It is required to have to have a separate bank account, as well as a Tax File Number (TFN) and Australian Business Number (ABN). A SMSF must lodge an annual tax return, and an approved auditor is required to audit its financial statements and the operations of the fund each year.
As a member and trustee of the fund, you are responsible for choosing how money is invested and benefits paid out. Therefore, there needs to be a clearly formulated investment strategy in place.
As part of such a strategy, it is possible for a SMSF to be used to buy investment property — either residential or commercial. However, there are strict rules and regulations in place as to how funds can be used for this purpose.
Investing in property through a SMSF
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.
SMSF borrowing and loans process
Strict rules apply to a SMSF borrowing money to acquire an asset, including property. Loans can only be undertaken through a limited recourse borrowing arrangement (LRBA); this minimises risk to other assets in the fund, as the lender’s rights are limited only to the asset that is being acquired.
Under LRBA rules, improvements and renovations to a property cannot be undertaken using borrowed money (although everyday repairs and maintenance are allowed); however, money that has not been borrowed can be used to make improvements to an asset.
A loan undertaken by a SMSF to purchase property will usually come with higher borrowing costs, and so this needs to be factored in to any investment decisions, as does the fact that all loan repayments can only be made by the SMSF (with funds derived either from rental income or superannuation contributions).
How we can help?
As can be seen from the above, managing a SMSF and purchasing property is notstraightforward. There are numerous rules and regulations which you mustadhere to, and as a member and trustee of the fund, you are responsible for ensuring compliance with all relevant laws and regulations. Serious penalties can result from the mismanagement of a SMSF.
For this reason, it is strongly recommended that you seek specialist advice before purchasing property if you have already established a SMSF, or if you are considering setting up a SMSF with the sole purpose of purchasing an investment property through borrowing.
As specialist mortgage brokers, Finncitti can advise you on setting up a SMSF in order to buy an investment property, and help you to decide whether this is the right investment strategy for you.
This can include advising you on the sums of money required to set up a SMSF, as well as what is needed to cover auditing, tax, legal charges and other running costs. Our advisers can also assist you in ensuring you have the requisite insurance in place, as well as helping to prepare for audits and submitting annual tax returns.
You can also call on our extensive experience to help you secure a loan to purchase an investment property for your fund. As this is required to be done via a LRBA, this is a more complex task than securing a regular home loan or investment loan, and so requires a degree of specialist industry knowledge.
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