Buying Property In A SMSF Rules
There are some important things to know when buying property with superannuation. Increased volatility in the markets over the last decade has sent many people to search for alternative options wth their superannuation fund. With the introduction of limited recourse borrowing arrangements in 2007, buying property with super has become a popular strategy for investors. The rules for SMSF property investment are constantly changing so always seek professional advice from a tax accountant or financial planner.
Changes in the SMSF lending rules allow your super fund to borrow to buy property under certain arrangements. One of the main reasons for this is that an individual can increase the size of their super fund assets using leverage and so have the potential to substantially increase their final superannuation balance using residential or commercial property investment. These borrowing arrangements are often referred to as "limited recourse borrowing arrangements" or LRBA's.
The Superannuation Industry (Supervision) Act (SIS Act) sets the ground rules for a Self Managed Superannuation Fund. Due diligence must be taken to ensure you invest correctly without breaching the SIS Act. The rules are much different than buying property in your own name or through an investment trust.
Firstly as a responsible trustee, one must prepare and implement an investment strategy for their SMSF that complies with the SIS Act. If a member of a self managed superannuation fund is considering investing into residential or business real estate, the fund requires an investment strategy that allows direct property investment. It's important to remember that an investment strategy needs to show the purpose behind it and how it will benefit the members of the SMSF (the sole purpose test). A licenced financial adviser can help you with setting up an appropriate investment strategy that adheres to the SMSF borrowing rules.
Can a SMSF buy residential or commercial rental property?
Your SMSF can have investments in the following types of real property:
- commercial property, this may include a factory, warehouse, business leased premises, a doctors surgery (also known as business real property) and
- residential property or real estate, such as units, semi's and houses.
Some of the SMSF rules and restrictions that apply include not being able to acquire a property from a person or entity that is related to a trustee member of your SMSF (so your super fund can't buy your own home from you). This restriction also applies to leasing the fund’s property to a person or entity related to a trustee or member of your SMSF (so you can't rent your super fund property to a family member or yourself).
The door is not totally closed though, the exception to the rule is that your SMSF is allowed to acquire from and lease business real property to a person or entity related to a trustee or member of your SMSF.
If gearing is involved in the purchase of a property a “holding” trust (or a custodial trust) must be set up to hold the new asset until it is no longer required as security (after the loan has been paid off). For further information on borrowing in an SMSF refer to the article on limited recourse borrowing arrangements also known as LRBA's .
Use this handy checklist when borrowing to buy investment property with your SMSF:
YES – A SMSF can purchase Business real property: at market value from a trustee or member of the fund or a related party and can be commercially leased to a business related to a trustee or member or related party. An example of business real property is a property that is wholly used by one or more businesses. A SMSF could for example purchase your business premises if that is where your business operates from and then lease it back to your business. Examples may include buying a warehouse, buying a retail store or a doctor's surgery premises with your super fund.
NO - A SMSF is not allowed to purchase a residential property: from a trustee or member of the fund or a related party, and cannot lease the residential property to a trustee or member of the fund or a related party. So your super fund cannot buy your own home or your existing investment property from you.
YES –A SMSF can purchase ‘Off the plan’ property such as an apartment. The deposit and costs such as the stamp duty to secure the purchase are typically paid using existing cash funds in super. Once the apartment is completed and strata titled, finance can be used to complete the purchase in line with the banks limited recourse lending requirements.
NO - A SMSF cannot purchase land and construct a house: on the block using borrowings, or purchase a house and land package using borrowings (this can breach the "single acquirable asset rule"). However In some circumstances vendors or developers may offer an off plan house and land package. The rules are constantly changing so check with an accountant or financial planner or the ATO if you are unsure how it may affect you.
What are some of the risks of a SMSF buying property?
A major risk worth noting is that the property may not value up when it is completed (or upon purchase) forcing the super fund to tip in a larger deposit, so one needs to do their due diligence (or have someone do it for them) to mitigate this risk, otherwise the whole super fund could be in a position of losing the deposit if it is unable to settle on finance. A cash buffer in the SMSF may help just in case the banks value it down depending on the property market or at the time the property completes. If you are considering buying new property read the guide on buying off the plan property or contact us for to speak to a SMSF property expert.
Of course another main risk is vacancy risk, a loss of tenant or no tenant at all can put a lot of cash flow pressure on the SMSF which could be detrimental to one's final retirement balance. Landlords Insurance is available and can reduce this risk.
Like any geared investment there is a risk that the super fund cannot meet the repayments of the loan, for example if interest rates increase dramatically or the rent decreases or you lose a tennant. Care should be taken to ensure the fund is able to meet its obligations each month. Forward thinking and proper planning can reduce this risk, if in doubt speak to a financial adviser.
Given the risks it makes sense to do proper research and due diligence to ensure the property asset stacks up with a view to providing a benefit to the fund and its members. If you don't know the population trends, infrastructure, demographic and economics of a location or suburb then it may be best to outsource it to a property consultant who can show you where to buy.
Stay compliant with the provisions of the ATO and invest successfully by sticking to the SMSF rules so you don’t put yourself and your retirement assets at risk. Read the ATO guide on borrowing to buy a single acquirable asset for more information. If in doubt always seek expert advice hiring good financial adviser or accountant will ensure you get it right the first time.
Guide provided by Greg Suefong who is a financial services consultant to private clients, advisers and accountants.
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Disclaimer: The guides on this site are prepared for MMC and provided solely for general guidance only. They are based on the interpretation of the laws and ATO rulings, including draft rulings, applicable to self managed superannuation funds and other information available as at January 2014. The content of this article is general only and does not consider your personal circumstances. Accordingly, before doing anything you should obtain professional financial, legal and taxation advice. This guide is not a substitute for seeking your own professional advice. While all care has been taken in the preparation of the contents of this guide, no members of MMC or related entities, nor any of their employees or directors gives any warranty of accuracy or reliability nor accept any liability in any other way, including by reason of negligence for any errors or omissions contained herein, to the extent permitted by law.