It’s no secret that Australians love brick and mortar property. However, what you might not know is that many are turning to self-managed super funds (or SMSFs) to invest in property, drawn to the idea of self-managed super as a means of gaining control over the management of their retirement savings.
SMSFs have been steadily gaining popularity since 2007, when they were permitted to borrow money to invest in property. However, this has also come hand-in-hand with a rise in reported scams. According to the Self-Managed Superannuation Professionals’ Association of Australia, SMSFs are being targeted by sophisticated swindlers who go to great lengths to deceive, including sending information packs to victims and even going so far as to set up fake websites.
Confusion surrounding the rules and regulation of property investment using SMSFs is likely to blame for much of the deception. You can only buy property through a SMSF, says Verdure Financial Planning Solutions adviser Katriel Warlow-Shill, that meets the ‘sole purpose test’ of solely providing retirement benefits to fund members.
This means your fund needs to be maintained for the sole purpose of providing retirement benefits to your members, or to their dependants if a member dies before retirement. Property purchased through an SMSF cannot be lived in by you, any other trustees or anyone related to the trustees, no matter how distant. Contravening this test may lead to the fund losing its concessional tax treatment as well as more serious consequences including civil and criminal penalties.
The other pitfall, says Warlow-Shill, relates to borrowing funds, which for SMSFs are not as straightforward as a normal home loan. Borrowing or gearing your super into property must be done under very strict borrowing conditions called a ‘limited recourse borrowing arrangement’. He recommends getting professional advice to ensure you know what you can and cannot do, and to avoid making mistakes like paying double stamp duty.
- Cash flow – Loan repayments must be made from your SMSF which means your fund must always have sufficient liquidity or cash flow to meet the loan repayments.
- Hard to cancel – If your SMSF property loan documentation and contract is not set up correctly, unwinding the arrangement may not be allowed and you may be required to sell the property, potentially causing substantial losses to the SMSF. It is therefore important to prepare an exit strategy with your financial planner.
- Possible tax losses – Any tax losses from the property cannot be offset against your taxable income outside of the fund.
- Cannot borrow to improve the property – Borrowed funds can be used to maintain a property but cannot be used to improve a property. Don’t get sucked in to buying a “renovator’s delight”.
However, with the right guidance, investment in property through an SMSF can be a financially rewarding pursuit with several tax benefits.
The maximum tax payable on the property’s income is 15% as tax on SMSF earnings is capped at the same rate as other super funds. Any expenses associated with managing the investment property such as interest repayments, council rates, insurance, repairs and maintenance are able to be claimed as tax deductions by the SMSF. You can also claim general wear and tear and fixtures.
Capital gains tax
If an SMSF holds a property for more than 12 months, capital gains tax is capped at 10%. Additionally, there may be no capital gains tax due if the property is sold after retirement and your SMSF is in ‘pension phase’. This could potentially save hundreds of thousands of dollars in tax.
There are also tax advantages for negatively-geared properties. Negative gearing can be used so interest and other costs related to holding the property can be offset against other taxable earnings and potentially reduce tax payable by your fund to zero.
For more information about SMSFs or other financial planning issues, please contact Verdure Financial Planning Solutions.