You’ve read the success stories about super funds paving the way to super profits through property investment, but how can you make your fund work for you? Your Investment Property walks you through the process, from setting up a self-managed fund to powering through the paperwork and ultimately purchasing a property.
Image Source: SMSF Lending
Features of an SMSF loan
Enables an individual to purchase residential or commercial property using their super fund for the deposit and transfers
- Complies with government legislation: SIS Act – Section 67 (4A)
- Funds the acquisition of eligible, income-producing real property
- Has limited recourse; the SMSF is the ‘beneficial owner’ until the loan is paid out
- Loan-to-value ratio (LVR) typically up to 70% for residential and 65% for commercial property
- Loan term up to 30 years for residential property, up to 20 years for commercial property
Source: InterPrac Financial Planning and NTAA Corporate
How to manage your SMSF investments
- Ensure the SMSF complies with the ‘sole purpose’ test
- Regularly review your investment strategy
- Ensure your strategy takes into account members’ retirement goals
- Consider the risks involved in investments
- Allow enough cash to pay all SMSF bills
- Remember to pay SMSF benefits
- Consider diversifying your SMSF’s investments
- Pay expenses from an SMSF-dedicated bank account
- Ensure the fund’s ownership of investments is assured
- Keep SMSF money and other money separate
- Don’t have the assets of your SMSF in another entity’s name
- Don’t use SMSF assets for personal use
Source: Running a Self-Managed Super Fund, Australian Taxation Office
SMSF trustee responsibilities
- Ensure the fund’s sole purpose is to pay retirement benefits to members
- Accept contributions and pay benefits (pension and lump sum) according to super and tax laws
- Make informed investment decisions
- Comply with restrictions
- Ensure an approved auditor is appointed for each income year
- Complete administrative tasks, eg lodge annual returns
- Review and update the fund’s trust deed and investment strategy
Source: Australian Taxation Office
FAQs: SMSF Loans
|Can I have an interest-only loan?
Yes – for a period of up to 15 years, depending on the loan and lender.
|Can I fix the rate?
||Yes – rates can be fixed for one year up to the full term, depending on the loan and lender.
|Can I redraw on the loan?
|What is the loan size?
||Minimum $100,000 and no set maximum, this is subject to lender approval of the property and SMSF borrowing capacity.
|What costs should I consider?
||You’ll need to establish a SMSF and trustee as well as a bare/security trust and trustee, plus pay all normal costs associated with buying property and taking out a loan, plus a lender’s legal review fee.
|What sort of property can I buy?
||Any residential investment property and any income-producing commercial property, including rural properties.
|Can I refinance an existing property?
||No, however ‘business real property’ that is held outside your SMSF or owned by a related party can be purchased by your SMSF using a SMSF loan.
|What about outgoings and other property costs?
Management fees, maintenance, rates and other costs associated with property ownership are the responsibility of the SMSF. All rent received belongs to the SMSF.
|What about negative gearing?
||The property can be negatively geared inside the SMSF. Normal superannuation contributions into your SMSF can be used to offset any shortfall between rent received and loan payments and outgoings. Any voluntary contributions you make may receive preferential tax treatment, consult your adviser.
Source: SMSF Loans
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"SMSF loans vary from regular loans in a number of ways and are generally more restrictive. They require higher deposits, have lower LVRs and prohibit redraw" Find out how much you can borrow using our SMSF calculator.
The sale contract is entered into with the property trustee holding legal title and the SMSF holding beneficial title.
Many changes regarding SMSF investment have recently been proposed. Consult the ATO website and qualified professionals to ensure you’re up to date on the latest legislation.
Gone are the days when self-managed superannuation funds (SMSF) were prohibited from borrowing to purchase investment properties. With one little addition to the Superannuation Industry (Supervision) Act 1993 (SIS Act) in September 2007, SMSFs suddenly became a whole lot more appealing for property investors.
Where SMSF trustees were previously prohibited from borrowing money, Section 67 (4A) of the SIS Act added an exception, which effectively allows a SMSF to buy an asset over time, providing it meets certain criteria.
Under the agreement, the fund selects a property, sets up a security trust and takes out a SMSF loan. The legal title of the property is held on trust by an independent property trustee, while the beneficial title is held by the fund. The SMSF pays an initial deposit and continues to make payments until the loan is paid out in full, at which time the asset and title are transferred to the fund. Alternatively, the property trustee may continue to act as a registered proprietor.
Section 67 (4A) of the SIS Act allows a fund to borrow money if all of the following conditions are met:
- The money is borrowed to buy an accepted asset
- The asset is held on trust so the fund acquires a beneficial interest in it
- The SMSF has a right to acquire legal ownership of the asset by making payments after acquiring the beneficial interest
- There is limited recourse; the rights of the lender against the SMSF for default on the sum of the borrowing and related charges are limited to the asset
This arrangement allows the loan to be paid off as the SMSF’s equity in the property grows. All ongoing costs related to the property are paid by the fund, which also has full control over renovating, leasing and selling, and collects rent as usual.
SMSFs were always a good option for those thinking ahead to retirement, and now, combined with the great Australian passion for property, they’re gaining even more devotees. Commissioner of Taxation Michael D’Ascenzo says SMSFs are the largest and fastest-growing segment of the superannuation industry. In a recent Australian Taxation Office (ATO) report, the total number of SMSFs in Australia was believed to be a huge 422,687, with 806,464 SMSF members, as at March 2010.
The ATO’s estimate for residential real property assets held by SMSFs in March was $12,806m and $43,601m for non-residential real property. So it seems Section 67’s (4A) exception has done much for the Australian property investment market and its profiting participants.
A growing number of Australians are enjoying the benefits that come from purchasing an investment property through a super fund. It not only sets up a promising path towards retirement, but also brings an entourage of tax benefits.
SMSF Lending specialist Vic Bulfone says super funds receive many tax concessions, including a maximum 10% Capital Gains Tax (CGT) payable on the sale of the property if it’s held for at least 12 months, and potentially no CGT bill if the property is sold in the ‘pension phase’. On top of this, there is a maximum tax of 15% payable on the property’s rental income, and any expenses such as interest, council rates, insurance and maintenance can be claimed as tax deductions by the SMSF.
Bulfone says one of the key advantages of investing in property through a SMSF is that it gives you greater control over your investment future. Through gearing, the SMSF can also acquire property worth more than the fund’s ‘net worth’. “Other than the property acquired, all other SMSF assets are safe and cannot be touched by any lender due to the ‘limited recourse’ provisions in Section 67 (4A) of the SIS Act,” Bulfone adds.
Firstly, because the SMSF trustee holds all the power, he or she also carries full responsibility. “Complying with the super and tax laws is your responsibility, even if you use a super or tax professional or a financial adviser,” explains the ATO. If the trustee fails to meet conditions, their ‘non-complying’ super fund could result in fines or even imprisonment.
Jason Pitkeathly, property investment strategist and mortgage finance specialist with InSynergy Financial Solutions, says that all the activities of the SMSF must comply with relevant legislation and regulations, as penalties for non-compliance can be severe.
Lenders are also far more rigid when it comes to SMSF loans, offering very restrictive loan products (variable and fixed rate only), lower loan-to-value ratios (LVRs) and therefore higher than normal deposits, as well as banning redraw and post-settlement loan increases.
Pitkeathly says arranging finance for SMSF-funded investments is far more complex than a normal property investment. “I guess for most, the biggest hurdle is having sufficient super to utilise this vehicle. You would generally require at least a minimum of $120,000 to even consider this, as funders require greater equity input to the purchase. The highest LVR I’m aware of using this vehicle at the current time is 80%. Funds are required to cover purchase costs and often, like in the case of a warrant, one year’s interest is payable in advance. Usually it’s structured so the property is geared to a level where it can provide a positive cash flow.”
Bulfone says setup costs are generally higher for property purchases through SMSFs; the ATO suggests a medium-sized fund will cost around $2,000 or more to run each year. “The SMSF may have to access cash reserves to meet the ongoing loan repayments and administration costs due to the negative gearing impact it may have on the fund,” Bulfone adds.
There are also restrictions on what can be purchased, with prohibitions on vacant land and property under construction, though this is currently under debate and some house and land packages are accepted.
Bulfone says that SMSF members are also banned from occupying the property, as this would breach the ‘in-house’ asset rule. However, the property can be transferred from the fund to a member after retirement, in which case he or she can live in the property.
Refinancing isn’t allowed, but some legislation changes have recently been introduced to parliament under the Superannuation Industry (Supervision) Amendment Bill 2010. Additional conditions will apply to arrangements entered into after the date of royal assent of the proposed law. The proposed changes, submitted to parliament on 26 May, include:
- The original asset being acquired under the arrangement must be a single asset or a collection of identical assets that have the same market value
- The asset held in trust under the borrowing arrangement can only be replaced by another asset in very limited circumstances that will be listed in the SIS Act or its regulations
- Super trustees can’t borrow to improve real property
- Other fund assets can’t be exposed, directly or indirectly, to a default on the borrowing
- The asset being acquired under the arrangement can’t be subjected to a charge other than in relation to the super trustee’s borrowing or the super trustee’s rights in relation to the asset. For example, the asset can’t be used as security for another borrowing
Craig Morgan, managing director of I-Financial Group, which operates SMSF Loans, explains that a number of changes relating to SMSF investment have been proposed since mid-March 2010. Consult the ATO website and qualified professionals to ensure you’re up to date on the latest legislation amendments before investing through your fund.
Step 1. Consider your options
Before deciding if a SMSF property purchase is right for you, you should consult qualified professionals and review your current situation.
You can appoint an expert such as a super fund administrator, tax agent or financial planner to help manage your fund. It’s wise to obtain the advice of an SMSF specialist such as Bulfone, who can help arrange the loan and accompanying legal structure for your personal needs.
Pitkeathly also recommends getting sound advice from specialists. “I’d select an experienced solicitor, accountant and investment property strategist who have been through the process and understand the complexities.”
However, the federal government announced on 26 April 2010 that the ‘accountants’ exemption’ under Regulation 7.1.29A of the Corporations Regulations Act 2001 will be removed. This effectively means that accountants will no longer be able to offer advice regarding SMSF establishment. Morgan explains that the change had been on the cards for a long time and will most likely come into effect later this year.
The ATO suggests taking six key steps when working out if a SMSF is right for you:
- Consider your options and seek professional advice.
- Ensure you have sufficient assets, time and skills to manage your own fund.
- Follow the super and tax laws and understand the risks.
- Tailor your trust deed and investment strategy to suit the members of your fund.
- Be sure you can meet your record keeping and reporting obligations.
- Make sure you understand your annual auditing obligations.
Step 2. Set up the SMS
The ATO website offers a wealth of information about self-managed super. Consult www.ato.gov.au/superfunds/ to learn more about the rules, requirements and processes involved.
You may want to engage the services of an SMSF specialist to help you get organised. The ATO suggests that a legal practitioner can draft your fund’s trust deed, an accountant or administrator can help organise the paperwork and register the fund with the ATO, and a financial adviser can help prepare an investment strategy.
Many SMSF professionals also offer kits and packages to simplify the process. Just check that it complies with recent amendments and suits your fund, its objectives and members.
Appoint trustees and obtain a trust deed
An individual trustee SMSF is comprised of one to four members, with each member being referred to as a ‘trustee’. No member can be an employee of another member, unless they’re related, and no trustee can be paid for carrying out their trustee duties. Each trustee must sign a declaration within 21 days of their appointment.
Trustees have a number of duties (see ‘SMSF trustee responsibilities’ boxout), such as appointing an approved auditor each year and ensuring the SMSF meets the ‘sole purpose test’ of providing retirement benefits to members at all times.
A trust deed is a legally binding document that defines the operating rules of the SMSF, including the rights and responsibilities of all trustees. You must ensure your deed is tailored to meet the individual needs of your fund, your members and your objectives. It must meet all legal requirements and be properly dated and signed by all trustees.
Register the SMSF with the ATO
Once your fund is legally established and all trustees have signed a trustee declaration, you need to register your fund with the ATO. You will also need to obtain an Australian Business Number (ABN) and Tax File Number (TFN) for the fund. You need to register the fund for GST if its annual turnover is greater than $75,000.
Once you’ve established your fund, you’re legally required to:
- lodge an SMSF annual return
- pay the supervisory levy, and
- have an audit report prepared
Open a dedicated bank account
Establish a separate bank account dedicated to your SMSF. This will keep your super fund assets well away from your personal assets and will help simplify account-keeping and administration.
Use this account to pay all fund-related bills and loan payments, and deposit contributions and rental payments. According to the ATO, although you don’t need to open a separate bank account for each trustee, but you will need to keep a separate record of their entitlement, called a ‘member account’. Each member account will record member contributions, any fund earnings allocated and benefit payments made.
Step 3. Devise an investment strategy
The ATO recommends establishing an investment strategy for the fund. This sets out trustees’ key objectives and a framework for making investment decisions to achieve them. “Property and shares are capital growth investments and tend to be more tax-effective,” explains the ATO. “This means the value of your investment should grow faster than in?ation, creating real wealth.”
Step 4. Obtain SMSF loan pre-approval
Whether you find the property first and gain loan approval after, or gain pre-approval first and find the property later, there’s no right or wrong decision, it’s completely up to you.
Bulfone explains that some professionals advise that the legal structure must be in place before submitting an application for finance, but he believes this accrues additional unnecessary costs for the SMSF. “I recommend to my clients that they obtain a pre-approval in the first instance,” he says.
SMSF loans vary from regular loans in a number of ways and are generally more restrictive. For example, they often require higher deposits, have lower LVRs and prohibit redraw. Many major lenders are now offering SMSF specialty products, but you may wish to engage the services of an SMSF loan expert.
Step 5. Find a property
SMSF trustees have the power to choose the property, whether it be residential or commercial, but there are a number of rules and regulations governing what can and can’t be purchased. First and foremost, the chosen property must comply with the ‘sole purpose’ test, as discussed above. It must be an established property; those under construction or refurbishment are prohibited, as is vacant land.
There are also some key differences between rules for residential and commercial property purchases. SMSF trustees cannot occupy a residential property until after retirement and upon transfer of title from the SMSF into their own name. It also must be bought from an arm’s length vendor, not a related party, in order to comply with the SIS Act’s ‘in-house asset rules’.
In comparison, commercial property that’s bought for business purposes can be purchased from a member or related entity and the businesses of SMSF members can occupy the property as a tenant.
Step 6. Set up a security trust
Once you’ve gained pre-approval for your SMSF loan, you’ll need to finalise the legal structure and establish a property trust, also known as the bare or security trust. This is to enable the property trustee to hold legal title of the property until the SMSF loan is paid in full.
You will need to appoint a property trustee, who should be independent from the SMSF trustee. You will also need to establish the property trust deed, which should be carefully reviewed to ensure it doesn’t create any tax or stamp duty issues.
Step 7. Gain formal loanAn SMSF loan simply enables individuals to purchase eligible, income-producing residential property using their SMSF for the deposit and transfers.
A key component of the loan is that there is limited recourse, which means the lender’s recourse is limited to the property in question and the SMSF’s other assets are protected.
“SMSF loan products are restricted by nature and are typically limited to either a variable rate loan or a fixed rate loan from one to five years,” explains Bulfone. He adds that SMSF loans for residential property generally allow up to 70% LVRs and 30-year terms, with up to five-year interest-only repayments. Mortgage offset accounts are also available with certain lenders.
Bulfone says some lenders apply standard variable consumer mortgage interest rates, while others apply commercial/business loan rate; some require a personal guarantee from super fund members; and some confirm loan servicing, utilising member contributions and rental income only, while others include personal income streams and offsets with personal liabilities.
“There are many SMSF loan products readily available in the market today, each with varying points of differentiation relating to cost, credit policy and structural requirements,” he adds.
“Once the loan is formally approved, the structure is then vetted by the lender’s legal department. It’s estimated that between 55% and 60% of legal structures fail this crucial step, which quite often leads to delayed settlements and penalty interest being applied.”
Step 8. Reach settlement
Contracts are then exchanged between the seller as vendor and the property trustee as purchaser. The contract is entered into with the property trustee holding legal title and the SMSF holding beneficial title.
The SMSF pays the deposit, balance, legal costs and stamp duty in the usual way as one would for a normal property investment purchase. There’s no need for the deposit to be paid through the property trustee.
The purchase is now complete. Congratulations, you’ve just used your super to take a big step forward in the property investment games.
Step 9. Manage the property – and reap the benefits
The SMSF then manages the asset in the same way as you would for any other residential investment property.
The fund pays all associated bills, including council rates, water rates, land tax, property management fees and insurance premiums. Trustees have full control over all leasing, renovating and selling decisions. The SMSF makes loan repayments to the lender as per usual and receives rental payments from tenants.
Bulfone explains that there is a maximum tax of 15% payable on the property’s rental income, and most property maintenance expenses can be claimed as tax deductions by the SMSF.
Step 10. Gain legal title
The SMSF is able to pay the loan out in full at any time, provided the particular lender and loan product allow it. Once the loan has been repaid, legal title can be transferred to the SMSF or the property trustee can continue to act as a registered proprietor.
The SMSF can direct the property trustee to sell the property to any third party at any time. If the property was held for at least 12 months, a maximum 10% CGT is payable. If kept until the pension phase, however, the SMSF may not be required to pay CGT at all.