Investing in property through a Self-Managed Super Fund (SMSF) can be an effective strategy for Australian investors.
However, this avenue comes with rules, regulations, and considerations that must be thoroughly understood. Such issues include a lack of investment diversity and liquidity considerations.
Investing in property through an SMSF presents several vital advantages for Australian investors. Nevertheless, assess whether investing in property is consistent with the investment strategy and risk profile of your SMSF.
Before buying a property through your SMSF, it’s crucial to understand the specific rules and criteria.
Eligibility Criteria and Property Rules
Depending on the property type, there are also tax benefits of buying an investment property. Of course, the property market and ongoing costs impact how much of a good idea it is. Use the following to ensure you pass eligibility and property rules.
1. Sole Purpose Test
The property must solely provide retirement benefits to fund members. This means the asset’s purchase must add a monetary value to your superannuation.
Think of it as an equivalent exchange. The money meant for retirement is used. Therefore, value must be added to support the trustees in their retirement like that money would have.
2. Related Party Restrictions
A rental property cannot be acquired from, lived in, or rented by a related party of a fund member. This means it can not be a holiday home, a residence for the children or bought from a cousin twice removed. No matter the relationship’s distance, residential property can not be utilised by anyone related to the trustees.
3. Commercial Property Leasing
Commercial premises can be leased to a fund member for their business but must adhere to market rates and specific rules.
This proposition is attractive for small businesses wanting to own the premises and pay rent directly to the SMSF. It’s important to process this correctly as if coming from a third party.
The rent paid must be at the market rate (no discounts) and delivered promptly and in full at each due date. A lease arrangement needs to be in place, clearly outlining the terms and conditions of standard commercial agreements, and the property will need to be periodically independently valued.
The fund must register for GST if the commercial property produces a gross rental income of over $75,000 annually.
4. No Altering Asset
You can’t make alterations that change the character of the property until you pay off the SMSF property loan. For example, you cannot develop a single house into a duplex. Furthermore, you cannot borrow funds to renovate an SMSF property. It would be best if you used cash within the SMSF.
Borrowing Conditions and Limited Recourse Borrowing Arrangement (LRBA):
You may use the super accumulated to borrow money if you do not have enough superannuation to purchase the property. This strategy is referred to as LRBA (Limited Recourse Borrowing Arrangement). An LRBA has stringent borrowing conditions.
To ‘limit the recourse’ of the lender, a separate property trust and trustee is established to hold the property on behalf of the super fund outside the actual SMSF structure.
The super fund must meet all loan repayments. If the super fund fails to do this, the property is held in a separate trust, and the account holder cannot access the super fund.
Borrowing in superannuation is only permitted to cover one single asset. Equity cannot be used for another SMSF property.
You can’t unwind the arrangement if your SMSF property loan documents and contract aren’t set up. Ensure the property is purchased and held in the name of the trustee of the bare trust to avoid stamp duty implications. You may have to sell the property, potentially causing substantial losses to the SMSF.
Maintain detailed documentation, with the loan withdrawn from the SMSF bank account and employer contributions used for loan repayments. This will determine if you have sufficient liquidity or cash flow to meet expenses.
A strategy is required to repay the loan in the event of illness, disability, death of members, or rental vacancy.
How do you act on a property purchase through an SMSF?
Investing in property through your SMSF offers a unique avenue for Australian investors to grow wealth.
However, it demands meticulous adherence to rules, careful risk assessment, and ongoing management.
By understanding the eligibility criteria and borrowing conditions, investors can navigate this complex landscape and potentially reap the rewards of a diversified and tax-efficient investment strategy.
It is prudent to seek professional advice to ensure compliance and optimise your SMSF property investment strategy for long-term financial success.
Due to GST and tax implications, it is essential to structure a property investment correctly through SMSF.
AFP assists our SMSF clients in finding a competitive loan that suits their objectives, considering both rates and features, whether it is for a residential or commercial investment property.
Contact one of our SMSF specialists at enquiries@afpaccounting.com.au or call (02) 7804 1849.
