Thinking of borrowing money to invest in property through a self managed super fund (SMSF)? We explore some of the ins-and-outs involved.
What’s more, low returns2 from many super funds and recent high levels of sharemarket volatility, combined with the perceived stability of the property sector are resulting in more Australians considering buying an investment property through SMSFs.
What property can an SMSF buy?
If you have an SMSF, you can use it to buy residential or commercial property. Any property the SMSF buys must meet the fund’s sole purpose test, that is, to provide retirement benefits to its members.
- Residential – The family home cannot be bought with your SMSF’s assets. However, the SMSF can buy an investment property that is rented out to tenants, who are not fund members or their relatives.
- Commercial – SMSFs can also buy commercial property, including your business premises. The property still needs to meet the fund’s sole purpose of providing retirement benefits to its members. So, the return from the property through rent and growth must be the focus for making the investment.
Borrowing through super
This is generally only available in SMSFs, and strict regulations govern borrowing to purchase property within an SMSF, and loan conditions are different than those for regular housing loans. The maximum loan amount relative to property value will generally be lower, and a range of conditions and risks need to be considered.
For example, the property must be held in a special arrangement known as a limited recourse borrowing arrangement. Under this arrangement, the property must be kept separate from the fund’s other assets. This ensures that if the fund defaults on making its loan payments, the lender has access to the property held as security for the loan, but not to other fund assets.
Where an SMSF borrows to buy a property, a security trust needs to be established recognising the beneficial interest of the SMSF and the rights of the lender. The trustee of this security trust holds the property in trust with the SMSF as the beneficial owner.
The pros and cons
Investing in property through an SMSF has advantages and disadvantages.
- Control and flexibility
With greater control over your super investments, you can manage your financial future to a greater extent through an SMSF. Also, an SMSF trustee has the flexibility to choose any type of investment (including a specific investment property) that is consistent with the fund’s investment strategy and suits the needs of the fund.
- Tax savings
If you buy and hold property within your SMSF until you retire, it will generally be exempt from capital gains tax and income tax (for any rent received) when your super enters the pension phase. Before you retire, any rental income generated will be taxed at a maximum of 15% and capital gains tax of up to 10% will be applied if you sell the property after one year.
When your SMSF invests in property and other asset classes, you may stand to gain from the benefits of diversification and increased financial security in the long term.
You may save on investment management fees if you choose to manage your own super, but it can be costly to set up your own SMSF and meet annual compliance fees. And when you borrow to buy property within your SMSF, it generally costs more than borrowing as an individual.
- Regulatory responsibilities
Managing investment property in your own super fund, particularly where borrowing is involved, requires the trustee(s) to meet specific regulations. There could be serious penalties for compliance breaches.
You generally need a larger deposit to buy a property in super than in your own name. It is generally not cost-effective to manage your own super or buy investment property through an SMSF, unless your SMSF has a total balance of at least $200,000.
2 According to the Australian Prudential Regulatory Authority (APRA) annual superannuation figures to 30 June 2012, in the 10 years to 30 June 2012, the industry-wide rate of return for large funds was 4.4% pa. Public sector funds recorded 5.5% pa, industry funds 5.1% pa, corporate funds 4.8% pa and retail funds 3.4% pa. Source: APRA media release 9 January 2013.
What you need to know
Any advice contained in this article is of a general nature only and does not take into account the objectives, financial situation or needs of any particular person. Therefore, before making any decision, you should consider the appropriateness of the advice with regard to those matters. If you decide to purchase or vary a financial product, your financial planner, our practice, AMP Financial Planning Pty Ltd and other companies within the AMP Group will receive fees and other benefits, which will be a dollar amount and/or a percentage of either the premium you pay or the value of your investments. You can ask us for more details.