This Whitepaper outlines the benefits and considerations of buying property through a SMSF (Self-Managed Super Fund), plus the advantages and disadvantages. Get an in-depth review and make an informed decision for your property investment strategy.
In Australia, superannuation is government supported and compulsory to ensure every Australian has funds available to them on retirement. Employers are required to pay a portion of an employee’s salary or wages into a superannuation fund and since the 1st of July 2014, the superannuation guarantee rate has been 9.5%. It is set to remain at this rate until 30 June 2021, when it will increase to 10% and eventually reach 12% on the 1st July 2025. Employees also have the option to make voluntary contributions each year into their superannuation fund. The following table outlines the superannuation guarantee rates as they currently stand:
With a growing amount of money being allocated to your superannuation each year, it makes sense to pay careful attention to how it is managed. With the right strategyyou have the potential to significantly grow money in your superannuation fund by the time you reach retirement age. There are plenty of different ways you can manage your superannuation, but two of the main types of superannuation funds are:
- Industry Funds – multi-employer funds run by employer associations and/or unions. Unlike retail/wholesale funds they are run solely for the benefit of members as there are no shareholders. Members have limited control over how their funds are invested as they are invested by the fund on behalf of the members.
- Self-Managed Super Funds (SMSFs) – are funds established for five or less individuals and are regulated by the Australian Taxation Office. Operating costs for a SMSF are higher but they allow members greater control over their SMSF investment strategy. It is important to note the same tax rates and concessions apply across both Industry Funds and SMSFs. However, if you have a Self-Managed Super Fund, you have the ability to purchase an investment property and develop your own SMSF investment strategy. This provides a number of important considerations compared to holding the asset in your own name.
The advantages and disadvantages of buying property through a SMSF are outlined below:
Advantages of using your SMSF to buy property:
- Your SMSF investment strategy is in your control, and you can decide exactly what investment property to purchase and how it is managed, rather than entrusting your funds to a stranger who may invest it in shares and managed funds which may not perform;
- SMSFs have a lower tax rate of 15% and only 10% on capital gains (nil once you are retired) for assets held longer than 12 months, compared to standard income tax rates if you purchase the property in your own name;
- SMSFs provide a safe form of asset protection for your investment property;
- There are potentially additional financial benefits to buying property through a SMSF, compared to holding it in your own name, depending on how the property is geared (this will be explained in further detail shortly);
- Once you reach preservation age (the age as which you can access your funds, usually between 55 and 60 depending on when you were born), your SMSF pays no tax on the property’s rental income or capital gain if sold.
Disadvantages of buying property through a SMSF:
- Buying property through a Self-Managed Super Fund is not appropriate for everyone - you need to have sufficient funds in your SMSF (usually around $150,000) plus you may still need to be earning an income to borrow funds via your SMSF to purchase an investment property;
- You can only borrow against the property once so you can’t access any equity built up in the property to borrow funds for the purchase of another property;
- Funds borrowed by the SMSF cannot be used to make any ‘improvements’ to the property;
- No members of the SMSF are permitted to live in the property at any stage;
- There is less diversity across the SMSF investment strategy as the majority of funds are tied up with one asset (keep in mind you have control over what asset is purchased which is often perceived as a positive);
- It may not always be easy to sell the property quickly if you need to access to the funds tied up with the property.
If you decide that buying a property through a SMSF is appropriate for your circumstances and you borrow money from a lender via your SMSF to purchase the property, you will generally be permitted to borrow up to 70% of the purchase price.
NOTE: If you plan to purchase more than one property in your SMSF, do not use all your funds to purchase the first property as you will not be allowed to borrow against it for the second. For example, if you have $400,000 in your SMSF and are looking to buy a $400,000 investment property you should only use some of the money to purchase the property and borrow the rest. This is because you will require a portion of the original $400,000 to use as a deposit for the second investment property.
It is important to know that the lender’s only security is the investment property and the lender can’t recover money from the SMSF in the event of a default. This means that any other assets held in the SMSF cannot be used as security. It also means a lender may subsequently insist the SMSF member/s provide personal guarantees.
If a loan is taken out via your SMSF, the property will be held in what is called a ‘bare trust’ for the benefit of the SMSF. Once the last instalment on the loan has been made, the property will be transferred into the SMSF as show in the following diagram:
Your accountant will be able tell you exactly how long it takes to set up a SMSF the costs involved and all the important information you need to know.
If you do decide to use your SMSF to buy property, you will need to decide how you will ‘gear’ that property. If you decide to negatively gear the investment (where expenses exceed rental income and you are unable to cover the interest only repayments of the loan), it is likely you may need to ‘prop up’ the investment if your compulsory superannuation contributions are unable to cover the shortfall. This can be done by making additional salary sacrificed contributions via your employer or personal contributions (if you are self-employed) into your Self-Managed Super Fund.
You will need to decide if this is a financially viable for you, if you can afford to make the extra contributions each month and have less cash in your pocket to spend, and discuss this with your employer to make sure they agree to make the extra before-tax contributions into your SMSF.
If you do make the contributions and they are offset by a negatively geared property within the fund, the contributions are effectively ‘tax free’ providing you with a significant financial benefit, but it comes with a greater level of risk.
For example, if your property is highly negatively geared and you are paying interest only on your loan, you are exposing yourself and your Self-Managed Super Fund if your circumstances change and you are unable to meet your financial obligations. For example if:
- You lose your job
- Interest rates rise
- You are no longer able to make additional contributions
- The property is vacant for any length of time with little to no rental income coming in
It can also be said that negative gearing in a super fund is not always effective due to the reduced tax rates applicable to super funds.
For these reasons (and if your circumstances allow it), a situation is often recommended where your property investment is close to being ‘positively geared’ whereby the income covers all the expenses associated with the property, and you are able to make principal plus interest repayments on the loan. Generally speaking, if your property is close to being positively geared, your compulsory superannuation contributions should be able to cover the principal plus interest component. This is without the need to make additional contributions to cover the loan repayments (although you can still choose to do so if you wish). This will enable you to claim the interest portion as a tax deduction, and you are getting ahead by also paying the principal component using funds which are taxed at a lower rate.
What’s more, when you take depreciation into account, your property will generally result in further deductions. This deduction can be quite handsome, particularly if it is a brand new property with maximum deprecation benefits available.
If your property is close to being positively geared you have less risk and more room to move if your circumstances change. In these circumstances you have the option to switch to paying interest only on your loan for a while if required. Plus, when it comes time to sell the property, if you have been paying principal plus interest you aren’t only relying on capital growth in the property as you should have reduced the principal loan amount too. This is the popular scenario when buying property through a SMSF because if you are still holding the property once you are retired, you will pay zero capital gains tax, or at worst 10% if sold prior to retiring.
NOTE: The long term capital gain benefits of buying property through a Self-Managed Super Fund rather than in your own name are significant. For example, if you purchase a property for $400,000 in your own name when you are forty years of age and sell it when are you are retired and then try and put the lump sum gain straight into superannuation fund, the lump sum contribution will be taxed (based on the lump sum amount and your age). However, if you purchase the same property via your SMSF and sell it when you are retired, you will not be taxed at all on the capital gains associated with your investment. This could potentially provide significant savings.
In summary, what does this all mean? Outlined below are five key points to remember:
- Buying property through a SMSF gives you control over your SMSF investment strategy and you can decide where and what you want to purchase;
- There are potential long term tax benefits associated with buying property through a SMSF rather than in your own name;
- Having an investment which is close to being ‘positively geared’ rather than highly negatively geared exposes you to less risk and still provides financial benefits;
- You pay ZERO capital gains tax on the property if you sell it once you have reached preservation (retirement) age;
- EXPERT ADVICE is key – don’t think you should be buying property through a SMSF because everyone else is doing it. Understand the risks and rewards. Most importantly, speak to a qualified specialist before you develop a SMSF investment strategy or establish a SMSF.
We believe it is for others to determine whether your Self-Managed Super Fund should invest in residential property. We feel this is the domain of qualified & experienced financial planners, accountants and the like in consultation with the SMSF trustees to make the determination.
In the end that they make the decisions that residential property is appropriate for their SMSF. As Australia’s leading construction, property & finance group Investor Assist know they are best suited to provide the SMSF with the most appropriate residential property offering.
For further information about buying property through a Self-Managed Super Fund, speak to your accountant or contact a Property Investment Specialist at Investor Assist, we can put you in touch with one of our team who are experienced with SMSF investment strategies. Book a free one-on-one appointment with us today, now is the time to start planning for your financial security in retirement.