Self Managed Super Funds (SMSFs) currently account for approximately $415 billion of Australian superannuation assets, and investments through SMSFs are expected to more than double to around $1.0 trillion by 2020. Fifteen per cent of assets in SMSFs across Australia are allocated to real estate with a value of $60 billion, which is up from 11 per cent in June 2006 and indicates interest among SMSF trustees in investing in property is growing.
If you have an SMSF, you can invest in all types of real property including residential property, commercial property, industrial property and even a farm (under certain circumstances).
Prior to September 2007, the capacity to use borrowed money to purchase an SMSF asset, such as real property, was extremely limited. Since then, the rules relating to borrowing within a SMSF have been relaxed slightly and fine-tuned, although the specific type of borrowing arrangement now permitted within SMSFs is still subject to strict requirements.
You can only borrow money to purchase an asset within a Self Managed Superannuation Fund by using a limited recourse borrowing arrangement (LRBA). A limited recourse borrowing arrangement means that any recourse the lender has under the borrowing arrangement is limited to the single asset purchased using the LRBA.
The good news for many SMSF investors is that the ATO’s interpretation of what SMSF trustees can do to maintain properties subject to a LRBA provides greater investment opportunities. For example, the ATO has clarified that it is possible to borrow via a LRBA and invest in an older investment property, and to renovate (but not ‘improve’) this property using borrowed money under the existing LRBA, under certain circumstances.
SMSF borrowing rules
When a self managed superannuation fund uses a limited recourse borrowing arrangement to purchase an asset, then the arrangement must satisfy the following conditions:
The SMSF uses the borrowed monies to purchase a single asset, or a collection of identical assets with the same market values;
The SMSF can’t use the LRBA monies to improve a purchased asset;
The SMSF trustees receive the beneficial interest in the purchased asset but the legal ownership of the asset is held on trust (the holding trust also known as a bare trust);
The SMSF trustees have the right to acquire the legal ownership of the asset by making one or more payments;
Any recourse that the lender has under the LRBA against the SMSF trustees is limited to the single fund asset (including rights to income). Lenders can legally demand an individual to provide a personal guarantee against personal assets;
Replacing the asset subject to the LRBA is possible only in very specific circumstances; and
Once the loan is repaid, legal ownership of the asset can be transferred to the SMSF.
Benefits of a property loan
As you may be aware, there are a number of benefits of borrowing to buy property through a SMSF:
Rental income – the proceeds of the rental income can be used to help pay off the loan. The SMSF also benefits from any capital growth.
Potential tax benefits – interest and other expenses relating to the property may be tax deductible. Where the rental income exceeds the deductible expenses, the net income of the SMSF is taxed at a maximum rate of 15 per cent. This drops to 0 per cent if your fund is in pension phase.
Possible CGT benefits – if you hold the property for more than 12 months, any capital gain will be taxed at a maximum rate of 10 per cent if sold in the accumulation phase (or 0 per cent tax rate if sold in the pension phase).
Aspects SMSF need to consider
Although borrowing to invest in super may seem relatively straightforward, it isn’t simply a matter of applying for a loan and buying a suitable property. SMSF trustees will first need to weigh the benefits of the strategy against the costs of setting up and maintaining the arrangement.
Legal considerations
The trust deed must allow for borrowing through an LRBA, and the investment must be consistent with the SMSF’s investment strategy. Those thinking about an LRBA must also consider likely risk and return, the liquidity needs of the fund and the extent of diversification in terms of the SMSF’s portfolio as a whole as well as the SMSF’s ability to meet loan repayments.
The final word
Borrowing to invest in property can help your Self Managed Superannuation Fund maintain an appropriate level of diversification within your fund. You need to carefully assess the risks associated with property in a SMSF against the long term investment objectives of maintaining bricks and mortar in the super environment.
*Nick Davos is an Associate Director of Moneywise Personal Financial Management. Email Nick on ndavos@moneywise.com.au with any queries you may have or call (03) 96497611