SMSF Series 3 - Buying Property through SMSF

Investing in property through an SMSF has grown in popularity in recent years, particularly since it became possible for SMSFs to borrow money to fund a direct property purchase.

However, the process is often complex, particularly when it comes to borrowing money. Before buying property through your SMSF, you should be aware of the specific rules and regulations that apply. We summarised key points that you should be aware in buying a property through SMSF below but we strongly recommend that you discuss your personal circumstances with us or a licensed financial adviser.

For advantages and disadvantages of using SMSF to invest in property, please read the article here (link).

Buying Investment Property with SMSF

If you are considering purchasing property with your SMSF, you should take note of the following factors.

The property must:

• Meet the ‘sole purpose test’ of solely providing retirement benefits to fund members

• Not be acquired from a related party of a fund member

• Not be lived in by a fund member or any fund members’ family

• Not be rented by a fund member or any fund members’ family.

While a property cannot be rented or lived in by a fund member or their relatives, most SMSFs are entitled to purchase their personal business’s premise, allowing the business to pay rent directly to their SMSF at the market rate. This is particularly appealing to small business owners.

Borrowing to Buy Property with SMSF

Borrowing to buy property through an SMSF is achieved through a Limited Recourse Borrowing Arrangement (LRBA).

To 'limit the recourse' of the lender, a separate property trust (i.e. a Bare Trust) and trustee is established to hold the property on behalf of the super fund, outside the actual SMSF structure. However, all the income and expenses of the property go through the super fund's bank account. The super fund must meet all loan repayments. If the super fund fails to do this, the lender only has the property held in the separate trust as recourse, and cannot access any remaining assets of the super fund. This is the main purpose of setting up a Bare Trust outside an SMSF structure.

For further details of LRBA, please read the article here (link).

Borrowing criteria for an SMSF is generally much stricter than a normal property loan (i.e. purchasing property as an individual). Many financial institutions will not consider lending to an SMSF. If your primary purpose for establishing an SMSF is to purchase property with a mortgage loan, it is strongly recommend you discuss with a bank or loan broker to identify whether you can obtain finance required for your purchase before you establish an SMSF. (We work with various loan brokers and help our clients for sorting out their financing requirements. Please contact us by clicking here https://www.goodpca.com.au/contact-us)

The loan also comes with higher costs, which needs to be factored in when working out if the investment is worthwhile.

Remember that loan repayments must be made from your SMSF. This means your SMSF must always have funds available to meet the loan repayments. The SMSF can fund the loan repayments through rental income on the property and through superannuation contributions into the fund.

Renovations

Whether or not you can make improvements to SMSF property depends on how your SMSF purchased the property.

If you purchased your SMSF property outright and it does not have a mortgage then you may use existing funds to make improvements. Subject to what it outlined in your SMSF deed and meeting sole purpose of the SMSF (i.e. providing retirement benefits), renovations that increase the property’s value or change its structure are allowed.

If you financed the purchase with a loan to purchase the SMSF property, you are not permitted to use additional borrowed money to make any improvements to the property. However, cash held in your SMSF can be used to make improvements to this property, as long as the improvements do not result in the asset becoming a different asset. Please be aware that you are not allowed to make significant changes to the original asset that was purchased using the limited recourse borrowing arrangement. Renovations that substantially change the asset will require a new Limited Recourse Borrowing Arrangement.

For further details on this topic, please read the article here (link).

Purchase the Property in the Correct Name

Ownership of the Property has to be shown in the name of the Fund (if freehold) or Bare Trust (if there is a property loan). Many people purchase the property first and then subsequently set up their SMSF and associated legal entities to arrange finance for settlement of the property. However, this (i.e. failure to purchase the property in the correct name) may incur expensive administration costs and cause stamp duty implications.

In particular, when SMSF borrows fund to purchase a property, the party to execute exchange of the contract for property purchase must be the trustee of your Bare Trust not the trustee of your SMSF.

Investing in Commercial Property

Generally speaking, investing in commercial premises through an SMSF has some advantages over residential properties.

Unlike residential property investment, commercial properties can be sold to an SMSF by its members, as well as being leased to SMSF trustees or an individual or business related to them. However, there are still a host of considerations.

Holding commercial properties in an SMSF is open to all SMSF trustees, not just small business owners. Many business owners use their SMSF to purchase a business premises and then pay rent direct to their SMSF. It's important to get this right as the rent paid must be at the market rate (no discounts) and must be paid promptly and in full at each due date.

The investment must also satisfy the overarching function of the SMSF, which is to provide retirement benefits for its members, that is the sole purpose test. To comply with the regulations, you must ensure the purchase provides a retirement benefit for the trustees, not for the benefit of your business. As a result, you need to consider the yield and expected growth in property value. If the property doesn't shape up, you may need to reconsider.

The tax consequences of buying and renting property

• If you buy a property through an SMSF, the fund is required to pay 15% tax on rental income from the property.

• On properties held for longer than 12 months, the fund receives a one third discount on any capital gain it makes upon sale, bringing any capital gains tax liability down to 10%.  

• If the property is purchased via a loan, the interest expenses are tax deductible to the fund. If expenses exceed income there is a taxable loss that is carried forward each year and can be offset on future taxable income.

• Once trustees start receiving a pension at retirement, any rental income or capital gains arising in the fund will be tax free (subject to certain conditions).

Valuing Assets

SMSFs need to value all of their assets at market value, and the valuation needs to be based on objective and verifiable data. If an SMSF holds commercial property, a real estate agent or registered valuer will need to provide an independent valuation.

If you have further questions, please contact us (https://www.goodpca.com.au/contact-us).

Disclaimer

This content is intended as a general guide for GOOD PEOPLE ACCOUNTING SERVICES clients. The information is general in nature and does not take into account your personal situation. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice. Although every effort has been made to verify the accuracy of the information contained above, GOOD PEOPLE ACCOUNTING SERVICES disclaim all liability (except for any liability which by law cannot be excluded), for any error, inaccuracy in, or omission from the information contained on this website or any loss or damage suffered by any person directly or indirectly through relying on this information.