What is the best way to get more from your super? There is no magic formula to this, but for some, the answer might be a self-managed super fund (SMSF). After covering the five essentials of SMSFs last month, I am continuing this SMSF series with the key considerations to make when using a SMSF to invest in property.
Across Australia, the number of properties owned by SMSFs is growing. This is because property represents a relatively low-risk investment with the potential for long-term capital growth. But when you invest in bricks and mortar, you must choose your property carefully.
Purchasing property with a SMSF
When purchasing property through a SMSF, you should be mindful of the regulations and risks. Here are the main considerations you should be aware of:
- The property must align with the fund’s investment strategy. This strategy should be documented and reviewed regularly.
- The SMSF may invest in any type of property, such as residential, commercial or rural.
- Residential property must be purchased from an unrelated party.
- The property is held in trust for the SMSF and must not be lived in or rented by a fund member or their friends and family.
- Strict lending rules apply and the fund is restricted to borrowing via a limited recourse borrowing arrangement. This loan can only be used to purchase a single property.
- All rent should be paid to the SMSF and repayments must be made by the SMSF.
- Any tax offset from the property only applies to the fund’s income, not your regular income.
What type of property should you purchase?
While SMSFs are not limited to purchasing residential property, this tends to the most common option. Some investors do choose to purchase their business premises instead, so that all their rent is paid into the fund. Unlike residential properties, which you aren’t allowed to reside in, this arrangement is within the guidelines.
With regards to residential property, it is tempting to purchase a renovator to generate higher capital gains, but there are restrictions surrounding what SMSFs can use a property loan for. Borrowed funds can only be used for maintenance, not to improve the property through renovations. For this reason, it is best to avoid purchasing properties requiring extensive work. Alterations may be made to the property once the loan is paid off.
To maximise the potential of the investment, you should instead be diligent with your property research. Consider the suburbs you wish to purchase property in, the growth potential of the area and what types of properties are in demand in that location.
The benefits of purchasing property with a SMSF
Property investment does come with its own risks and lending restrictions, but there are benefits to choosing property as part of your investment strategy.
- All tax benefits can be claimed by the fund, effectively reducing its tax liability.
- No capital gains tax is payable if the property is sold when the fund is in the pension phase (paying an income to members).
- If the property is sold prior to the pension phase, the capital gains tax is capped at 15% if the property has been held for less than 12 months prior to the sale, and at 10% if the property has been held for more than 12 months.
- Lenders may not access the fund’s other assets in the event of a default.
Before investing in property, consider the time you need to manage a SMSF and the borrowing costs of purchasing the property, as these are often higher for SMSFs. Ask yourself whether you are better off purchasing an investment property outside of a SMSF. Remember that you won’t be able to offset any losses from a negatively geared property against your regular income, so consider which scenario will be the most beneficial to you.
When purchasing a property, the fund should have a professional plan and exit strategy in place, to ensure members can manage cash flow without the fund incurring any losses.
In the final part of this series, I’ll look at other options you have for retirement planning.
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