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Based on data from the Australian Taxation Office (ATO), real estate is a popular asset class where SMSF funds are held. The latest ATO report shows that out of more than $980 billion held within all SMSFs, nearly $110 billion is invested in non-residential (i.e., commercial) property, while over $58 billion is allocated to residential real estate.
There is also over $72 billion held in limited recourse borrowing arrangements (LRBAs), otherwise known as SMSF loans. These total to about $240 billion, or a quarter of the value of all assets held.
However, before diving into property investing using your SMSF, understanding the regulatory requirements is crucial to ensure your fund remains compliant. SMSFs are subject to an annual audit, and any breaches may result in legal challenges and severe penalties.
Here are the five common mistakes Australians make when using their SMSFs to invest in property - and how you can avoid them.
Mistake no. 1: Using personal funds for property transactions
The ATO mandates strict separation between personal assets and those of the SMSF to maintain the fund's integrity and compliance with superannuation laws. This ensures that the SMSF operates solely to provide retirement benefits to its members, as stipulated by the Superannuation Industry (Supervision) Act 1993.
Mixing personal funds and SMSF transactions breaches this requirement and can result in penalties and the risk of the fund being deemed non-compliant. Additionally, improper transactions can affect the fund's tax concessions, potentially leading to higher tax liabilities.
How to avoid it:
- Establish a dedicated bank account for the SMSF, through which all transactions must be conducted.
- Do not use personal funds for SMSF expenses. If unavoidable, reimburse the personal account promptly, documenting the transaction to maintain clear records.
- Keep detailed records of all transactions, including receipts and invoices, to demonstrate compliance during audits.
Mistake no. 2: Misunderstanding limited recourse borrowing arrangements (LRBAs)
A limited recourse borrowing arrangement (LRBA) or an SMSF loan allows a self-managed super fund to borrow money to purchase a property, with the lender's recourse limited to that asset. However, many trustees misunderstand the intricacies of LRBA.
For instance, the property must be held in a separate holding trust until the loan is repaid. Further, the SMSF cannot use borrowed funds to improve the asset beyond its original state, which means trustees cannot take out an SMSF loan to build on vacant lands as this is considered an improvement or renovation.
For commercial property, additional restrictions as to the type of property an SMSF can buy may apply. SMSF lenders may impose restrictions beyond the law and refuse to lend for properties seen as higher risk, difficult to value, or hard to sell, such as farms and racetracks.
How to avoid it:
- Before entering into an LRBA, ensure a comprehensive understanding of its structure and limitations.
- Ask your SMSF lender to clearly explain all loan conditions and any specific property restrictions.
Mistake no. 3: Acquiring property from related parties
The ATO defines "related party" to include relatives of fund members, business partners of members and their spouses or children, any company or trust the member and their associates control, and standard employer-sponsors.
SMSFs are generally prohibited from acquiring residential property from these aforementioned related parties.
This restriction is in place to prevent the members from using their superannuation savings for personal benefit before retirement. Breaching this may lead to penalties, deem the fund non-compliant, and disqualify or prosecute the trustees.
However, if the property qualifies as "business real property" - meaning it is used wholly and exclusively in a business - the SMSF may acquire it from a related party, provided the transaction is conducted at market value.
How to avoid it:
- Before any transaction, conduct due diligence and assess whether the property doesn't breach the restriction and qualifies under the exceptions.
Mistake no. 4: Incorrect property title registration
Failing to correctly register the property title can jeopardise the SMSF's compliance status.
If the property is purchased outright, without borrowing, the title must be registered in the name of the SMSF trustee - either individual trustees or a corporate trustee.
If the property is acquired through an LRBA, that is, through an SMSF loan, the legal ownership of the property must be held in a separate holding trust until the loan is fully repaid. Registering the property in the name of the SMSF trustee instead of the holding trust when an LRBA is involved can lead to non-compliance.
How to avoid it:
- Before entering into an LRBA, establish a holding trust with a trustee that is separate from the SMSF trustee.
- Conduct periodic reviews of property titles to ensure they accurately reflect the current trustee structure and comply with any changes in legislation or fund arrangements.
Mistake no. 5: Using borrowed funds for property improvements
Under an LRBA, borrowed funds can be used to maintain or repair the property but not to improve it beyond its original state. Using an SMSF loan for improvements or renovations can breach superannuation laws and result in severe consequences.
How to avoid it:
- Ensure all work done only maintains or repairs the property, without materially altering it.
- If improvements are necessary, fund them using SMSF resources, not borrowed funds.
Avoiding these mistakes and adhering to restrictions helps ensure your SMSF remains compliant, safeguarding the fund's assets and the retirement benefits of members.
For more information on SMSF loans, visit loans.com.au today.
Image by Jakub Żerdzicki on Unsplash
