Using a self-managed super fund (SMSF) to purchase property can generate wealth and tax benefits, but this is not a decision that should be made lightly
When buying property through a SMSF, the purchase must be for the purpose of supporting the SMSFs investment strategy to build wealth for retirement.
Setting up your SMSF allows you to diversify your investment portfolio by using your super funds to purchase residential or commercial property. When you invest using your cash, you're limited to only the amount of money you have in your fund.
However, investing in property allows you to leverage the amount you have in your fund and increase it by borrowing the remaining amounts you require. This lets you increase the overall value of your SMSF portfolio using the bank's money, as well as deriving rental income from your investment property.
Before you invest into property in your SMSF, you need to ensure that your SMSF trust deed is properly set up to allow for direct property investment which is why it’s crucial to speak to a SMSF specialist.
Any Australian with a minimum SMSF balance of $120,000 and access to the required finance can make a direct purchase of an investment property through a SMSF. However, due to the strict governance of direct property purchases from SMSFs, it is strongly advised that you seek independent advice before going forward with this decision.
Generally buying property through a SMSF is relevant for those investors that are about 20 years away from their retirement. This is because they will not only have more super funds at their disposal but they are more likely to hold the property after retirement to reap the tax benefits.Back to top
You are able to borrow money to purchase an investment property in your SMSF. This is an opportune way to leverage the amount you already have within your fund and increase the value of your portfolio. However, you’ll need a balance of $120,000 or more before you consider borrowing funds to purchase property in this structure.
Keep in mind that there are strict rules and regulations surrounding how the loan is structured, as well as how the purchase is structured.
If you plan to borrow to gear your super funds to purchase property, this can only be done through strict borrowing conditions which is known as a ‘limited recourse borrowing arrangement.’ These loans are quite complex so before you structure the arrangement, make sure you get independent advice.Back to top
What does a lender consider when reviewing the fund’s ability to service the loan?
Generally the fund must demonstrate that they have sufficient liquidity to meet its loan commitments. The lender will also limit the amount you're able to borrow in comparison to the property value. The loan amount is usually restricted to a maximum of 70% of the property value.
Lenders will generally take the following into account:
- Rental income
- Annual contributions
- Other additional earnings or personal contributions (e.g. tax deductions by self-employed borrowers)
Seek independent advice
It’s recommended that you speak to a qualified SMSF specialist when defining your fund’s investment strategy or making changes to your investment portfolio particularly due to the strict compliance and auditing regulations.
To borrow money using your SMSF to invest in property, you’ll need to set up a trust that specifically recognises the rights of the lender and the interests of the SMSF in the property. For instance, it needs to state that the SMSF is the beneficial owner but the trustee of the security trust holds the property in trust for the SMSF.
Limited recourse borrowing arrangement
In order to borrow money within your SMSF to invest in property, you will need to set up a security trust that needs to be worded in a specific way to recognise the rights of the lender, but also recognises the interest of the SMSF in that property.
The loans offered for SMSF are complex and are usually referred to as 'limited recourse borrowing arrangement'. Limited recourse borrowing arrangements (LRBA) allow SMSFs to use borrowed funds to purchase an asset or several assets that have the same market value. WIth an LRBA, your super fund is not at risk if the loan is defaulted.
Essentially, this means that the loan documentation contains conditions that say if your SMSF defaults on your loan repayments, the bank isn't able to come after other assets within your fund. It's only able to take the property used as security for the loan in this event.
Learn more about the SMSF application process.
Alex and Lucy consider an SMSF
Savvy property investors Alex and Lucy are in their mid 60’s and are thinking of diversifying their investment portfolio (which is currently worth $1.2 million) by purchasing a property in Rouse Hill, NSW through their SMSF.
After speaking with a financial planner and a SMSF specialist, Alex and Lucy decide that investing in property through a SMSF is not the best option for them. With a SMSF balance of just $80,000 and limited ability to access finance due to the high establishment costs and complex terms of a limited recourse arrangement, Alex and Lucy are not comfortable with the level of risk of this investment strategy. Plus, they are disappointed to learn that they would not be able to conduct renovations to the property.
A SMSF balance of just $80,000, the high establishment costs and complex terms of a limited recourse arrangement, and the inability to renovate the property are all factors which contribute to their decision.
Instead, Alex and Lucy believe that a tenants in common arrangement may suit their situation better as it would enable them to split the borrowing across their home and their super fund.
They decide to focus on paying off their debt and making additional contributions to their super fund for the remainder of their twilight years.
There are several benefits to buying investment property in an SMSF, such as:
The ability to leverage the existing funds within the SMSF using loans to purchase an asset can help to increase the portfolio value. It also means purchasing a more expensive asset than you otherwise would have been able to afford.
Repayments for a loan can come from rental income, interest earned on cash invested within the SMSF, dividend income from shares owned by the SMSF, or from contributions made from members.
Most assets held within an SMSF can be protected from creditors in the case of bankruptcy.
There are other things to consider when using an SMSF for asset protection purposes:
- Tax advantages. Holding a property in an SMSF can offer tax saving benefits. These include being exempted from capital gains tax if you decide to sell the property while the super fund is still in pension phase. Any rental income received by your SMSF is taxed at 15% which is relatively lower compared to the average personal tax rates. You may also be able to limit the capital gains tax you pay after selling an investment property from your SMSF to 10% if you've owned the property for more than 12 months. When you compare this to owning an investment property in your own name, it can represent a significant tax saving.
- Business advantages. It's possible to buy commercial property in your SMSF that can be leased to your own business. This allows you to pay rent from your business, which is tax deductible. It also allows your SMSF to receive rental payments that are in excess of your own contributions, which can be a good way to increase the amount going into your SMSF over the low contribution limits that have been imposed.
Buying property through an SMSF provides you with direct control of your investments and a better understanding of where your money is invested.Back to top
Before going ahead with a geared property investment, you should decide whether the investment reflects the investment strategy and risk of the fund.
- Establishment costs. SMSF property loans are typically more expensive than other property loans. There are thousands of dollars in set-up costs and often higher fees involved in getting a loan via your SMSF. SMSFs generally require around $10,000 in legal and administrative fees coupled with higher interest rates applied to the limited recourse loan facilities.
- Property occupancy. When you buy property through a SMSF, you can’t purchase residential property to live in or for any family member to live in as the SMSF trustee, its members or relatives can’t benefit from the property
- Complex terms. To borrow funds from your SMSF to invest in property, you need to set up a security trust that recognises the rights of the lenders and the interests of the SMSF. These terms need to be structured in a precise way, which can make it difficult. There are strict conditions governing how SMSFs acquire property which must be adhered to.
- Inability to offset tax losses. Any tax reductions from the property cannot be offset against your taxable income outside the fund if you’re negatively geared.
- Restrictive exit terms. If your SMSF property contract is not set up properly, exiting the arrangement may be difficult and you may be required to sell the asset. Another factor to consider is that until the SMSF loan is repaid in full, you cannot make any changes or upgrades to the property. Buying property through a SMSF is generally only suitable for funds with at least $200,000.
Your SMSF can purchase residential or commercial property, but it must meet the purpose test to show that it is capable of providing retirement benefits to any fund members when required. This means it's important to check your investment strategy, arrange finance carefully and manage the rental aspect of the property until it's time to sell it.
You can purchase residential property within your SMSF as long as it is to be rented out to a tenant who is not related to any member of that SMSF. This means you're not able to lease it back to yourself. You may also not purchase a property from a member or any related party.
Likewise, you're able to purchase commercial property in your SMSF, including holding your own business premises in this structure. It's still important that the property meets the sole purpose test of offering retirement benefits to its members, but you aren't as severely restricted as to who you can choose as tenants. You are able to lease the premises back to your own business or to a member of the fund or to a related party.
What should I be aware of for a commercial purchase in a SMSF?
Most people use their SMSF to purchase commercial property to lease back through their business, however there are some things you need to consider:
- Sole purpose test. The investment purpose must meet the ‘sole purpose’ test which states that the investment offers retirement benefit to the fund’s members.
- Commercial lease. The terms of the lease must be compliant with the ATO requirements in the sense that you cannot lease it back for a discounted rate.
You can only buy property through the SMSF if the property:
- Satisfies the ‘sole purpose’ test
- Is not lived in, or rented, by a fund member or a fund members’ affiliates
- Is no smaller than 50 square meters
You can visit the Australian Taxation Office (ATO) website for more information.
What should I consider when buying property through an SMSF?
If you’re planning to purchase property through a SMSF, you should ask yourself the following questions:
- What is my investment strategy?
- Is the property suitable?
- What is the risk involved? Does the risk suit the SMSF investment property and risk profile? Am I comfortable with the risk?
- Is it worth setting up an SMSF to buy property if I haven’t already established one?
If you’re thinking of purchasing property through an SMSF, be wary of the costs involved, such as:
- Upfront fees
- Legal fees
- Stamp duty
- Property management fees
- Bank fees
Renovating a property owned by an SMSF
If you purchase an investment property in your SMSF that needs to be renovated, this can be done in some circumstances. This means you're able to renovate and upgrade a kitchen or bathroom to an existing home, or add a swimming pool or extend the home to add another bedroom or living area.
You will need to fund your renovations using existing funds only, as you aren't able to borrow for renovation purposes. Existing funds can be comprised of cash already held in the fund, or from contributions received or from rental income received.
Developing an investment property owned by an SMSF
Some property investors prefer the idea of building wealth by purchasing an older property with a view to sub-dividing and developing the land by building one or more new properties in its place. This isn't allowed if there is still an outstanding loan owing on the property.
In order to pursue an investment strategy that includes subdivision and development of a property the entire loan amount outstanding must be repaid in full and the borrowing arrangement has been properly concluded. When this has been done, the opportunity to develop a property further becomes possible.Back to top
Are there alternatives to buying property through a SMSF?
- Tenants in common. If you want to purchase a property but you don’t have enough funds in your super fund, then you may want to consider a Tenants in Common (TIC) arrangement. This would allow you to split the borrowing across your family home and your super fund. For instance, if you’re thinking of purchasing a property for $500,000, you could borrow against $250,000 existing equity in your home and use the remaining $250,000 from your super fund.
- Reverse mortgage. Similar to a home equity loan, a reverse mortgage allows you to access the equity in your home to fund your lifestyle needs.
Can I purchase vacant land through my SMSF?
While you can purchase residential or commercial real estate, you cannot buy vacant land through your SMSF.
Are there penalties for non-compliance?
For those who do not comply, the Australian Securities & Investments Commission (ASIC) imposes a $10,200 penalty on each corporate trustee for SMSF compliance violations.