This article aims to answer a popular question that is often asked at Australian barbeques, “Should I use my super to purchase a property investment?” Using a self-managed super fund (SMSF) to buy investment property offers many different benefits. For one, you will be able to pool your assets with the other members of the SMSF. We will discuss some important self-managed super fund property rules, followed by an analysis of the pros and cons of buying property through an SMSF.
Some important rules relating to SMSF property investing
Buying property through an SMSF is a highly regulated way of investing in property because your property investment(s) is subject to strict government guidelines. There are four well know rules that need to be adhered to when considering to buy property through an SMSF. The investment property:
- Must pass the ‘sole purpose test’, which is designed to determine ensure that the fund exists only to provide retirement benefits to the members (or their dependants in the event of death).
- Cannot be bought or sold to a relative of a fund member.
- Must not be lived in by a fund member or any fund members’ relatives.
- Cannot be rented by a fund member of any fund members’ relatives.
SMSF property investing includes commercial properties. But these types of properties are also highly regulated. For example, a property investor who buys commercial property through an SMSF is allowed to lease the investment property to a fund member for business purposes. However, the rent needs to be at market rates.
It’s also important to know what an SMSF property can cost. There are many fees involved in the process, which will reduce your super balance. You need to be aware of all the costs before signing up, so make sure you get insight into upfront fees, advice fees, legal fees, bank fees, ongoing management expenses, and stamp duty.
Another important aspect to understand is SMSF borrowing. There are very strict rules related to borrowing, known as a “limited recourse borrowing arrangement” (LBRA), and you will only be able to buy a single asset with this arrangement.
Self-managed super fund property investments have become increasingly popular. With the government’s Super Home Buyer scheme being made available to first home buyers from 1 July 2023, real estate investors have been brushing up on their knowledge on SMSF property investing.
What are the advantages of SMSF property investing?
One of the benefits of buying property through an SMSF is the offset tax on superannuation together with the ability to reduce taxable income by providing pre-tax contributions to pay off the investment property.
Here are some additional advantages to SMSF property investing:
- All the income you make through an SMSF will be capped at a 15% tax rate.
- SMSFs can enjoy a 30% capital gain discount when a property is sold.
- If you buy a property while the SMSF is in the pension phase, your income won’t be affected by tax as long as the balance is under $1.6 million.
- Your capital growth will be available when you retire.
There are disadvantages to Buying property through an SMSF
Of course, you must assess whether the investment is consistent with the strategy and risk profile of your SMSF. Some of the geared property risks are as follows:
- More expensive loans. Loans for SMSF property can be a lot more expensive than other kinds of property loans, which is very important to consider.
- You need cash flow. Loan repayments will be deducted from your SMSF. That means your fund must always have enough cash flow or liquidity to cover the costs of the loan repayments.
- You can’t back down. You need to make sure your SMSF property loan documents and your contract are properly set up. Otherwise, you won’t be able to back down from the arrangement. The only option would be to sell your property, which can lead to major losses.
- Tax losses. The possibility of tax losses is great because you can’t offset them from the property against the taxable income outside your fund.
- The property will remain as it is. This means you won’t be able to make any alternations or improvements to the property that may change its character. At least not until you finish paying your property loan.
Some additional disadvantages one should consider before buying property through an SMSF to are:
- You won’t be able to access the benefits of your investment until you retire or reach the preservation age
- You won’t be able to use the property and neither will your relatives until you retire
- Financial statements and tax returns must be completed every year
- You must cover an SMSF setup fee and ongoing compliance expenses
- The complexity of SMSF rules is such that you must take the time to understand them well so this personal financing structure can be beneficial to you
What is our general advice assessment of SMSF property investing
This is the final article of our series on the most popular types of legal entities Australian property investors can use to purchase investment property. We use the Strategic Investors Personal Financing Structure scorecard to give our verdict on self-managed super fund property investments.
- Leverage: With all the complexities involved in buying property through an SMSF, as highlighted in the disadvantages section of our article, our general advice score for Leverage: 1/10.
- Compliance: With some many rules and regulations governing self-managed super fund property investments, our general advice score: 1/10 for Compliance.
- Setup Costs: Because of the complex nature of SMSF property investing, there are significant time and effort involved to set up this type of legal entity. Seeking professionals to advise you, draw up the contracts and time taken to acquire knowledge brings our general advice score for Setup Costs to 4/10.
- Asset Protection: This is a major benefit to property portfolio investors when it comes to investing in property through a self-managed super fund. A SMSF is its own legal entity, this is why property investors have limited liability. Our general advice score: 10/10 for Asset Protection.
- Property Taxes: remembering that property investors who choose to buy property through an SMSF are taking a long-term view with their investments, the income tax benefits and CGT discounts on investment property outweigh the inability to claim negative gearing benefits in a SMSF. Our general advice score: 9/10 for Tax.
- Liquidity and Flexibility: Compliance has a very large impact on the liquidity and flexibility of buying property through an SMSF. Recalling all the rules we highlighted, combined with many of the disadvantages we touched on SMSF property investing, we give a general advice score of 1/10 for Liquidity and Flexibility.
- Wealth Transfer: SMSF wealth transfer is a complex one. You would need to seek a professional to discuss all these. Examples of important terms that are useful when it comes to the wealth transfer of self-managed super fund property investments are the different types of death benefit nominations, tax implications such as lump sum or income streams; to name a few. Our general advice score is 8/10 for Wealth Transfer.
Our verdict on building an investment property portfolio using SMSF property investing
Our general advice verdict investing in property through a SMSF is 5/10.
Always seek professional advice when forming your own property investment strategy, so that you have something that is tailored to your personal circumstances and financial aspirations. Where you are in your own financial life cycle is also an important factor to consider.
We conclude some closing remarks for real estate investors with different levels of investment property experience.
Verdict for property investors who are beginners: Novice property investors usually do not have the knowledge required to benefit completely from buying property through an SMSF. First time investors also require a greater degree of flexibility and generally value the benefits of negative gearing. Our general advice score is 2/10. This type of legal entity is suited to those who do not foresee a need to liquidate the property until age 65 and are intent of salary sacrificing from an early stage to take advantage of pre-tax contributions to superannuation.
Verdict for property investors who are experts: Investing in property by buying property in an SMSF is suited to expert real estate investors. But given that we have covered all the other types of legal entities, some my suit the majority of real estate investors compared to SMSF property investing. Our general advice score for this group of investors is 6/10.