Self Managed Super Funds – Buying a property in an SMF
Buying a property in an SMF
Since 2007, self managed super funds (SMSF) have been permitted to borrow money to invest in all types of real property including residential property, commercial property and industrial property.
Prior to 2007, an SMSF could purchase property but it was not permitted to borrow money to fund that acquisition.
There are many advantages to owning property in a SMSF, including having direct control of super investments, paying reduced or no income tax on rental income and a lower capital gains tax rate being applied on the disposal of the property.
However, there are a number of strict rules and regulations which must be complied with and complex borrowing arrangements.
In this article we look at some of the common mistakes made by individuals in setting up their own SMSFs and offer tips for avoiding the pitfalls of borrowing to purchase real estate through a SMSF.
What property investments are allowed?
A SMSF can have investments in commercial property and residential property provided the property purchased meets the “sole purpose” test – of supporting the SMSFs investment strategy in building wealth for retirement.
Some examples of property investments which are not permitted because they don’t meet the “sole purpose” test include the following:
- A property which is purchased for the purpose of redevelopment breaches the sole purpose test as it may be interpreted as the fund carrying on a property development business.
- Owning a holiday home which is intended to be used for private purposes (even one weekend a year) breaches the sole purpose test.
- An SMSF cannot buy a residential property for members to live in, or for any family member to live in.
An SMSF is generally not allowed to purchase residential assets from a member or an associate of a member.
An SMSF can purchase commercial, retail or industrial property at market value from a trustee or member of a fund and that property can be commercially leased to a business related to a trustee or member or related party, as long as the transaction is on a commercial arm’s length basis.
Some of the risks of a SMSF buying a property
There are strict rules and requirements governing the establishment and running of a SMSF. If the rules and requirements are not met, the fund is at risk of being deemed non-compliant, which can result in significant penalties and additional taxes.
Some of the more common reasons why a fund might be deemed non-compliant include the following:
- Making errors on the property acquisition documentation (for e.g. title deeds containing an incorrect owner), which can lead to capital gains tax assessments and double stamp duty being payable later in the life of the fund.
- Making payments for the purchase of the property from a bank account other than that of the SMSF.
- Using the property for personal use.
- If a property that is already owned by you is transferred into an SMSF then you need to be aware of the considerable costs of such a transaction and the fact that if your property is negatively geared you may lose the tax benefits of such an arrangement.
- In general terms acquiring a property through an SMSF is more complex and costly then acquiring it in your personal name.
SMSF borrowing structures
There are special rules that apply where an SMSF borrows money to purchase property.
A SMSF can only borrow to purchase an investment property through a limited recourse borrowing arrangement (LRBA). In a LRBA, the lender holds the purchased property as security, however any existing or other assets held by the SMSF cannot be used for additional security. Nonetheless, lenders can still require an individual to provide a personal guarantee.
When a SMSF borrows money, it is required to establish what is known as a “bare trust”. This is a special purpose trust which simply holds the property being purchased on trust for the SMSF.
The bare trust is the registered holder of the property until the loan is repaid. When the loan is repaid the legal ownership of the investment property reverts to the trustee of the SMSF.
The purpose of requiring a bare trust and borrowing through a LRBA is to protect the other assets of the SMSF and to ensure that members do not lose their entire retirement fund if the property investment turns sour.
Buying a property through an SMSF can be a valuable investment strategy. However, the decision to set up an SMSF and purchase a property through that vehicle must form part of the overall investment strategy of the SMSF.
Simply because it is possible to buy a property through an SMSF and borrow to acquire that property does not always mean that this is the best way for the SMSF to invest its funds.
Any decision to buy a property through an SMSF should only be made after first obtaining advice from a financial planner, accountant and your lawyer. If you wish to borrow to allow the SMSF to acquire the property then, in addition, advice will need to be sought from your proposed lender regarding their requirements for any loan to the SMSF.
For more information regarding Self Managed Super Funds, see our other articles by clicking on these links; Self Managed Super Funds: Do it Yourself Super, and Self Managed Super Funds: Having a Company as a Trustee.
If you would like advice in relation to buying a property in your SMSF please contact please contact Brian Tetlow or Emma Bragg on (02) 6140 3263 or email [email protected].