Building for retirement

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Libby Dale and her partner Effie Metaxas wanted to add property to their investment strategy, and soon realised that buying through their SMSF was the way forward

Libby Dale and her partner Effie Metaxas have taken an interest in property investment for some time now. They’ve invested in a whole range of property trusts over the years, but direct property ownership was something that Effie in particular had dreamed of.

“I’m not really the one that wanted it,” explains Libby. “I just went along with it and then our financial advisor, Tony Gilham, advised us that there were some real benefits.”

These benefits came in the form of some generous tax breaks for investors who choose to buy their investment property through their self-managed super fund (SMSF).

“Originally we were going to do it outside of the fund but, once we understood the benefits of SMSF property investment, it didn’t make any sense to be paying for it with money that we’d be taxed on at 40% and then potentially pay capital gains tax when we sold,” says Libby.

The capital gains tax (CGT) issue was particularly potent given the fact that the ATO’s super rules would allow them to sell the property CGT-free within a relatively short timeframe.

“I’m 50 and my partner’s 49,” says Libby. “And our advisor told us that if we bought the property as part of our super fund and sold it after age 55 then there wouldn’t be any CGT.”

Plus, the rental income that would be going towards paying off the mortgage would be taxed at an enviably low rate (15% maximum), thanks to the property’s SMSF ownership structure.

A little help

Libby and Effie were soon convinced of the merits of SMSF property investing, but had no idea where to start looking for a suitable property. Not only did they need to find something that would tick all the boxes that a regular property investor would have on their checklist, they also had to find something that would work within the ATO’s restrictive framework for SMSF property investment.

“We didn’t feel confident to look at yield versus capital growth, what area to go for, what sort of yield to expect and all that sort of stuff,” explains Libby. “Plus you’re not allowed to make any improvements to the property, and there are some other funny limiting rules around it.”

And with the ATO imposing some extremely punitive measures against those SMSF trustees who make improvements to their property and break the rules, Libby and Effie decided to seek some expert advice on finding the right property for their purposes.

“We were really careful when we purchased, and Cate from Empower Wealth helped us find a place that didn’t need any improvements,” says Libby. “I think it’s key when purchasing with a SMSF that you’re really happy to leave it as it is. Because the last thing you want is even to come close to the line with what could be considered an improvement rather than maintenance.”

Close to home

The Melbourne-based couple were keen to pick up a property that wasn’t too far from home, and they finally plumped for a two-bedroom unit in Hawthorn, just 3km from their own house.

“If I had a portfolio of half a dozen properties it wouldn’t bother me as much, but I think in terms of setting up the property, organising a managing agent and so on, I liked the idea of proximity,” explains Libby.

They settled on the property in May 2011 for $430,000. The unit was already tenanted, drawing in a rent of $397 per week, which meant that Libby and Effie’s SMSF fund had picked up a property that instantly provided a gross yield of 4.8%. The rent received exceeds all holding costs, making the property positively geared.

“The rental income from the property more than covers the interest on the loan. You pay your 15% tax on that income, but it covers the body corporate fees, water and council rates, landlord insurance, and all other costs, plus the loan repayments. It’s cash flow positive, and what’s leftover stays in the super fund,” explains Libby.

Creative thinking

When it came to financing the purchase, Libby and Effie were advised to act as lender to their own SMSF. Now, this strategy may sound a little strange, but it allowed the couple to avoid the complications of applying to a commercial lender for an SMSF mortgage. Plus, with the loan on their own home almost paid off, they were able to release some equity from the property without enduring any hardship themselves.

The plan was to take out a line of credit (LOC) on their home for the $150,000 required to lend to the SMSF, and then have the SMSF repay the loan at the same interest rate as the LOC. With their SMSF paying off their LOC repayments, Libby and Effie wouldn’t personally be out of pocket.

“So the SMSF pays us interest only, in arrears, on whatever interest we pay the bank on our existing line of credit. And that really made it simple. The conveyancer that we used said our case was incredibly simple because there was no bank involved,” says Libby.

The pair admit that when their financial advisor brought up the idea of lending money to their SMSF personally, they thought that it was all “getting too stupid”, but when it came to applying for the LOC the simplicity of this strategy became clear. Plus, taking out a LOC on their own home came with its own benefits. 

“We just went to the Commonwealth Bank who’ve got the mortgage on our existing house, which has got pretty much nothing on it, and said ‘can we have another $150,000?’ They said ‘if you take half a million we’ll give you another half a per cent off the interest’. So we took half a million on a line of credit, but only ever drew $150,000 on it,” says Libby.

An agreement was then drawn up between the SMSF and the couple, and they were able to lend it funds required to purchase the Hawthorn unit. 

Future plans

Looking ahead, Libby points out that the terms of the loan stipulate that it must be paid back by 2014, and that the SMSF will need to hold on to the property for a further two years before it can be sold CGT-free.

“That’s not too long, but we haven’t decided what we’ll do then,” she says. “I guess we’ll have a look at what other mix of investments are in our super fund. I feel that it’s a bit heavy, having $430,000, or 40% of the fund, in one investment.”

She adds that, if it’s possible to keep the $150,000 loan on the property a little longer then she’d be more comfortable about keeping hold of it, “because then we’ve only got $280,000 in that one asset”.

But for the next few years they’re quite happy to hold on to the property at least until they’re able to sell it off tax-free and pour any profits into their retirement nest egg.

How they structured their finances:

  • Libby and Effie take out a line of credit (LOC) on their home.
  • They withdraw $150,000 from their line of credit. They now owe the bank $150,000.
  • They lend that $150,000 to the SMSF.
  • Their SMSF now has the funds to buy an investment property.
  • All rental income from the investment property goes back into the SMSF.
  • The SMSF pays Libby and Effie monthly interest on the $150,000 loan at the same rate as it’s being charged on their $150,000 line of credit.
  • Thanks to the SMSF’s loan repayments, Libby and Effie are able to repay to their bank the monthly interest being charged on their line of credit (LOC).
  • By 2014 the SMSF must pay the $150,000 loan back to Libby and Effie in full, allowing them to give that money to their bank and pay out their line of credit.

Do you want to know more about investing in property through an SMSF? Join the conversation on our forum

Do you have more than $120k in your super fund? You could use your super to buy property - Find out how

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Comments
  • Walter Strohbeck says on 17/02/2012 01:48:43 PM

    Quite powerful to hold properties within a SMSF as well as outside. I did know that we can lend money to our SMSF's. I just presumed you can't cause you can't rent a property from your SMSF.

    Walter @ http://realtestate-investment-australia.com

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