SMSF Property Investment

Did you know that you can buy residential or commercial investment property with an SMSF? That’s an investment option that’s not available to most public industry and retail superannuation funds.

Prior to 2007, SMSFs weren’t allowed to borrow funds, which meant that investment properties weren’t a viable option for most. However, since this restriction in the Superannuation Industry Supervision (SIS) Act was eased, SMSFs can borrow funds under specific conditions.

In this article, we’ll explain:

  • Why it can be a good idea to invest in property with your SMSF.
  • The importance of diversifying your SMSF investments.
  • The major rules and legislation relating to SMSF investment properties.
  • The costs of buying an SMSF investment property.
  • Why you must set up a special trust for a self-managed super fund investment property.
  • What happens if you don’t set up a special SMSF investment property trust.

For comprehensive details on SMSF property borrowing and financing issues, see our SMSF Borrowing for Property article.

Why invest in property with your SMSF?

Property is an asset class that has the potential to provide both income and capital growth.

Like superannuation, property is best regarded as a long-term investment (ideally, ten years or more). Although there might be flat periods during the economic cycle, Australian residential property prices in good locations have a long-term record of capital growth. There is an old saying that there are three important considerations when buying real estate: location, location and location.

  • Any income that you earn from the investment property (i.e. the rent you earn from your tenants) can be used to cover your loan repayments.
  • Any capital gain that you might make if you sell the property remains in the tax-effective environment of your self-managed super fund.

The investment earnings of SMSFs are taxed at a maximum rate of just 15% before you retire. And any capital gains made on assets (like an investment property) held for longer than 12 months are taxed at just 10%.

Once you retire, no tax is payable on investment earnings or capital gains from assets that provide your self-managed super fund pension. This is known as exempt current pension income.

An SMSF investment property could be a good option for you if you are in the following position:

  • You are at least ten years from retirement. Property is a long-term investment for potential capital growth. It is also not a liquid investment, so you don’t want to tie your funds up if you or any of your fund members are approaching the pension phase.
  • You have stable employment.
  • You continue to make regular contributions to your self-managed super fund.
  • Have a deposit of about 40% of the purchase price in your SMSF.
  • Have a diverse portfolio of investment assets in your self-managed super fund.

While there are many potential benefits to investing property, it’s an asset that should form part of a diversified investment portfolio for your SMSF.

In other words, don’t put all your eggs in one basket.

Investing in different types of assets (e.g. fixed interest, property and shares) helps to spread your risk. If one sector isn’t performing as strongly, others may be able to compensate. You’ll be less exposed to downturns or flat periods in a single asset class.

Diversification should be one of the pillars of your SMSF investment strategy.

What are the rules for SMSF investment properties?

Self-managed super funds are regulated by the Australian Taxation Office (ATO) and the Australian Securities and Investments Commission (ASIC). If you are considering using your SMSF to invest in property, it must comply with four regulations:

  1. It must meet the sole purpose test. That is, it must be bought purely to provide retirement benefits for the members of your SMSF. A self-managed super fund can have up to four members. You can’t obtain any benefits now from buying an investment property through your SMSF. For example, you can’t use it as a holiday house, and nor can any of your relatives. You also can’t buy your own home with your self-managed super fund.
  2. It cannot be bought or transferred from another one of your SMSF fund members or any of their relatives. This ensures that any self-managed super fund transactions are made on a commercial “arm’s length basis”. That means the buying and selling price of the property will reflect its true market value.
  3. It cannot be lived in by an SMSF fund member or any of their relatives.
  4. It cannot be rented by an SMSF fund member or any of their relatives.

However, you can buy your own business premises as a commercial investment property transaction with your self-managed super fund.

What does it cost to buy an SMSF investment property?

Besides the buying price, SMSF investment properties can have several associated fees and charges that will reduce your fund balance. These can include:

  • Legal fees (e.g. conveyancing and the setting up of a trust to hold legal ownership of the property).
  • Stamp duty.
  • Ongoing property management fees (e.g. repairs and maintenance).
  • Bank fees (e.g. a loan application fee).

However, many of these expenses will be tax deductible from your self-managed super fund’s income.

It’s also important to understand that investment property loans tend to be viewed as higher risk by lenders. Higher interest rates are usually charged accordingly.

This is because there is a risk that an investment property may not always be able to attract tenants. That is, there may be periods where it is vacant and not generating a rental income.

Loan repayments for SMSF investment properties must be made from the fund itself. This means that the fund must always have enough cash flow to make these repayments. Having fixed interest investments and shares in your self-managed super investment portfolio can help to ensure this liquidity.

writing on glass investing

Why do I have to set up a trust for an SMSF investment property?

Legal ownership of the investment property when it is purchased is held in a trust (called a security custodian trust) set up for that specific purpose prior to purchase.

Setting up this trust should therefore be done before you choose a property and approach a lender for finance. An SMSF investment property must be bought in the name of the security custodian trust, not in the name of an individual member or the SMSF.

The self-managed super fund acquires beneficial ownership of the property when it is purchased. The loan and associated documentation will need to reflect this. It means that the self-managed super fund will be credited with all income and capital growth associated with the property.

All financial transactions are then done directly by the SMSF. For example, loan repayments and expenses associated with the property.

Upon full repayment of the loan, legal ownership is transferred to the SMSF.

It’s important to note that an SMSF trustee cannot also be a trustee of the security custodian trust that holds the legal title to their investment property. That’s because you can’t legally hold something in trust for yourself. However, you can set up a separate company to act as a trustee.

The security custodian trust must be managed to ensure compliance with SMSF legislation. This means that all paperwork must be kept up-to-date and this is something that will be checked as part of your annual SMSF audit.

Non-compliance with superannuation legislation could result in a forced sale of the property at a potentially substantial financial loss to your SMSF.

 

couple in retirement

How we can help

There are multiple factors to consider when deciding whether SMSF property investment is a good option for you and structuring it in the most tax effective way.

Our expert SMSF Accountants would be happy to speak or meet with you to discuss your situation. We’ll take the time to understand your circumstances and provide advice that maximises your financial position.

Contact us now.

This article is for general information purposes only and has not been prepared with reference to the circumstances of any particular person. You should seek your own independent financial, legal and taxation advice before making any decision in relation to the material in this article.