Residential property investing through a self-managed super fund (SMSF) has become increasingly popular both with investors and promoters.
If it’s something you’re considering, it’s important that you understand the rules, what needs to go right and what could go wrong.
Buying property through an SMSF can be difficult and costly, compared with buying it in your own name. Plus, in addition to the usual problems of bad tenants, unexpected bills and strata issues, there’s an added layer of do’s and dont’s to be aware of.
Firstly, members of the SMSF can’t use the property, nor can they lease it to family members.
Further, employing related tradespeople can lead to unintentional breaches of the governing legislation for super funds (the SIS Act) by the SMSF trustees.
If the SMSF is borrowing to purchase the property, a costly limited recourse borrowing arrangement is required. You also need to ensure you don’t spend borrowed money on items the Australian Tax Office might classify as ‘improvements’ and be careful when dealing with properties on multiples titles and property development as these can also cause the SMSF’s trustees to breach the SIS Act.
If SMSF property investing has so many worries, why do people do it?
The answer is tax. The tax rates for a super fund are very generous: it pays 15 per cent tax on ordinary income and 10 per cent on capital gains (provided the investment has been held for over 12 months).
But if the super member has started taking a pension, the fund pays no tax on the assets supporting that pension at all. This means if you make a healthy return on a property investment, you don’t need to share much (or any) with the tax office. But you need to be sure that this potential tax saving is worth it.
If you can afford to buy an investment property in super without borrowing, your main concern is its investment merits. But if you decide to borrow, the success of your investment centres on two key factors: the capital growth rate of the property and the future for SMSF loans.
When you’re borrowing to invest in property, the interest on the loan typically offsets the rental income or if it’s greater, gives rise to a ‘negative gearing’ tax deduction. As a result, in the initial stages of the investment there isn’t much benefit investing through an SMSF, and if it’s negatively geared, the result may be worse than if you bought the property in your own name as the SMSF tax rate is likely to be lower than yours.
In these instances, the overall tax benefit from investing through an SMSF hinges on the level of capital growth you can achieve. The tax savings will be substantial if you make a big profit on the sale, but if you’re borrowing a large amount and achieve little (or no) capital growth, you may find the complexity of investing through an SMSF was pointless.
Buying an investment property through an SMSF may also be a bad option if differential pricing on property loans becomes the norm, or if SMSF lenders withdraw from the market altogether.
AMP recently announced that it was increasing the interest rate on investment property loans by almost half a per cent. If you have the ability to draw down on your home mortgage to purchase an investment property, then by using an SMSF you’d be paying half a per cent extra for every year you have the loan.
National Australia Bank recently stopped writing SMSF property loans and AMP put a temporary freeze on all property lending. As regulators increase capital requirements or if the market slows, other lenders may decide to follow suit.
It’s important to note that SMSF loans are not as ‘set and forget’ as a normal home loan. They typically include ‘review events’ that allow the lender to review (and possibly terminate) the loan for events as simple as the fund switching into pension mode.
Imagine going to the trouble of establishing a borrowing arrangement for your investment property only to find you end up paying a higher interest rate, or worse, your loan is terminated altogether, forcing you to sell the property?
Borrowing within an SMSF to invest in property is taking a punt on strong capital growth and no adverse changes to the SMSF loan market or super rules. It’s important to understand these points and the consequences – before you start out.
To help compare the merits of investing in residential property inside and outside of super we’ve built a Property Calculator (click HERE to download). This calculator compares the financial returns from investing through super or as an individual, and allows key assumptions to be changed so that a range of scenarios can be considered. Richard Livingston and Annika Bradley represent the online financial advice service Eviser. This article contains general investment advice only (under AFSL 469838).
This information has been prepared without taking account of your objectives, financial situation or needs. Because of this you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation and needs.
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