Pros and Cons of Using a Self-Managed Super Fund to Buy Property
With more Australians setting up Self-Managed Super Funds (SMSF), we look at the risks, benefits and regulations on using a SMSF to buy an investment property.
Since the introduction of the compulsory employer contribution scheme in 1992 under the Keating Labor Government, Australians have become comfortable with the concept of setting aside money to fund their retirement.
But increasing numbers of Australians are taking it a step further, investing more than the compulsory amount and then taking direct control of these retirement savings by setting up a Self-Managed Super Fund (SMSF).
Recent figures suggest that over the last five years the number of SMSFs has grown by some 31 per cent. According to the Australian Taxation Office, they now make up 29 per cent of the $2.1 trillion total superannuation pool ($622 billion).
For many the appeal of an SMSF is its ability to be used for property investment, as well as tax benefits and the extra control you have over your precious nest egg. However, it also takes a great deal of preparation and ongoing attention to ensure it is managed correctly and that the many regulations are being met.
Benefits of Property Investment With an SMSF
Some of the substantial positives of investing in property through your SMSF include:
- It’s a relatively stable and low risk investment compared to other options and can offer considerable returns
- It offers a way to diversify your investment portfolio
- Positively geared investment properties can generate additional revenue stream
- You have more control over property investment than you do with other options, such as shares which are subject to fluctuations and market forces
- Members of SMSF can gain access to significant tax efficiencies, only available in the superannuation environment including:
– no capital gains tax once member(s) retire
– loan repayments can effectively become tax deductible (provided members salary sacrifice)
– negative gearing benefits inside SMSF environment.
– income after expenses and any capital gains on the disposal of property is taxed at a maximum rate of 15%, compared with rates of up to 46.5% that a regular investor could be paying.
- Employer superannuation contributions can be used to help repay any loan associated with the property
- Assets held in a SMSF, will under normal circumstances, be protected against general debt recovery and bankruptcy proceedings.
Risks of Property Investment With an SMSF
The risks can be quite similar to purchasing a property outside a SMSF and include:
- They are not as liquid as shares – it takes time to market, sell and settle a property
- There are costs involved with buying and selling a property
- Property prices may go down, eating into your capital growth
- The property may be untenanted for a period of time
- Property is essentially not a set-and forget investment option – there are ongoing expenses and management factors which will require your attention
- You are not exempt from paying stamp duty when buying a property using your SMSF.
Property Rules and Considerations
You need to consider the following regulations and key points related to any property purchase bought through an SMSF:
Type of property: There are restrictions on the type of property, where it is located and how it is used. Some of the property types an SMSF can buy include residential, commercial, industrial, retail and vacant land.
Location: Many countries will not recognize a super fund as the legal owner of a property, however investing in Australian property will avoid these complications and will also make things easier for you in calculating the relevant taxes payable.
Investment only: The property is strictly investment only – your SMSF cannot buy your family home, or a holiday home used by yourself or family members. Unlike an investment property that you own personally, where you can live in the property for a time yet claim it as an investment for the period it is tenanted, you can never live in a property owned by your SMSF. Any tenants you have living in the property must be third-party – that is, not related to you.
Personal interests: You also can’t use your SMSF to buy a residential property from you personally or anyone related to you. However, you can use your SMSF to buy a commercial property from yourself or your associates, which is a popular strategy for business owners.
Proportion of funds invested in property: There are no restrictions on the number of properties an SMSF can own, nor is there a limit on the proportion of super funds that can be invested specifically into property. However, it is generally recommended that property investment is used as a means of diversifying your asset portfolio, rather than accounting for 100 per cent of your super funds, so as to spread the risk across different asset classes.
SMSF payments: All monies relating to an investment property including the purchase costs, possible mortgage repayments, maintenance expenses and incoming rental payments, must be paid directly into your SMSF. You won’t be able to pay bills or receive rental payments using your personal bank accounts. This helps to streamline your SMSF revenues for tax declaration purposes, since you can easily track your earnings and expenses.
Naming rights: When buying a property using your SMSF without borrowing, you will be required to list your SMSF as the buyer on all documentation. When purchasing a property using borrowing, the property must be purchased in the name of the Security Custodian Trustee Company. It cannot be purchased under your own name or that of your trustee. In doing so, your SMSF assumes sole responsibility for ownership of the property and is solely liable for all related expenses.
Fully insured: It is a good idea for any SMSF-owned property to be fully insured. As with the title deeds, the insurance policy will need to be in the name of your SMSF, not you personally, and be paid for from the SMSF account. Investment-related insurance is also tax deductible.
Tax on Property Earnings
By using your superannuation to buy property, the tax implications on SMSF-owned properties can be slightly different to that of a traditional investment property:
- Capital Gains Tax (CGT): This is only charged when an asset is sold for a profit. SMSFs are not exempt from paying CGT, however a discount of one-third is offered to complying SMSFs where an asset has been owned for at least 12 months. It is also worth noting that the rate of CGT payable may depend on whether your SMSF is in the accumulation stage (pre-retirement) or payout stage (once you have retired and are drawing down payments).
If you’ve started a pension in your SMSF, you will pay no capital gains tax when you sell the property.
- Tax rates: Any rental income from your property that is paid into your SMSF is usually taxed at 15 per cent, as opposed to the personal tax rate of up to 49 per cent if income is earned outside of the SMSF. When you reach the preservation age and draw a pension from your SMSF, the rental income from your property is tax-fee.
- Tax deductions: Through your SMSF, you are eligible to claim tax deductions against virtually all costs associated with the purchase, management and sale of the investment property including interest payments on a loan, insurance, advertising for a tenant and letting agent fees. Another often overlooked deduction is property depreciation, which can save thousands in tax over the life of an investment property.
Funding a property purchase using your SMSF
- Buying a property outright – it’s less complicated and ensures that your SMSF won’t be losing revenue in repayments, and will provide a steady income stream with which to fund other investments or to grow cash savings. You will need to ensure that your SMSF has enough capital to fund the purchase, as well as the associated buying costs and ongoing management expenses.
- Using a mortgage to buy a property – it is possible to obtain a mortgage for your SMSF to buy a property. One of the major differences to buying as a private investor is that your SMSF will need to establish a Security Custodian Trust Structure, which must be a company. The directors and shareholders of the Security Custodian Trustee Company must be the trustees of your SMSF (if you have Individual Trustees) or the directors of the company (if you have a company as trustee for your SMSF). SMSFs with corporate structures can usually borrow approximately 20 per cent Loan to Value Ratio from most lenders. If the SMSF trustee is an individual, they can usually borrow approximately 30 per cent Loan to Value Ratio.
Obtaining Personal Ownership of the Property
Two methods of transference will enable you to take up residence in the property during your retirement years:
- Once you retire and your SMSF begins to pay you a pension, you can opt to have an SMSF-owned property be paid out to you as a benefit from the fund.
- Alternatively, you can arrange for your SMSF to sell the property to you personally on the open market. It is worth remembering though that by assuming ownership of a property from your SMSF, your SMSF will be liable for Capital Gains Tax.
Cohen Handler Client Case Study
Jack and Jill, both aged 45 and employed full-time in the retail industry were keen to use their superannuation to purchase an investment property. They appointed one of Cohen Handler’s buyers agents who specialises in property across Sydney’s eastern suburbs, who found them a two-bedroom apartment in Potts Point, which they bought for $1.1 million.
Their investment strategy is simply to build wealth for retirement, balancing out lower yields for higher capital growth. Super was used for 30 per cent deposit with a fixed interest rate.
Three years later the property has increased in value. Comparable properties in the same building are selling at $1.62 million and $1.710 million. Their employers continue to pay them super, which is contributed to the SMSF loan. They have had the same tenants for the past three years. Overall capital growth, rental yields and super payments are paying off their property.
The owners have the option of living in this lovely apartment when they turn 65, which not only provides a strong growth trajectory for units in the area but also offers great appeal for retirees who are attracted to low maintenance apartments in beautiful suburbs with water views and the latte lifestyle.
As outlined in this article, there are a number of unique considerations to take into account when investing in property with an SMSF. It requires careful planning and it is important to consult a financial planner and lawyer when setting up a SMSF. In addition a buyer’s agent can assist you in finding a suitable property that ticks all the boxes when it comes to your short- and long-term expectations.
Cohen Handler’s team of expert buyers agents are specialists in finding the right property for you at the right price. If you are interested in purchasing an investment property through a Self-Managed Super Fund (SMSF), contact us now.