The decision to purchase an SMSF property requires careful consideration.
This is perhaps why, in June 2019, the Australian Tax Office (ATO) reported that of the total estimated value of assets held by the almost 600,000 SMSFs, investment property only makes up about 13%.
Nonetheless, there seems to be increasing popularity in using an SMSF to buy an investment property.
You may have picked up that there are various advantages to purchasing an SMSF, but have no idea where to start when it comes to evaluating the risks.
What regulations do you have to comply with? Can you live in the SMSF property that you purchase? Or could you use it to run your small business from?
Because this is an area of property investment that can get a bit tricky, we’ve put together this ultimate SMSF property buying guide to help you decide whether it’s a suitable option for you.
What Is an SMSF?
In terms of Australian law, your employer is required to put money aside on your behalf into a superannuation fund while you are working. This is to ensure that you can have an income once you’ve retired.
However, if you would prefer to manage the account yourself, you can opt to use a self-managed superannuation fund (SMSF).
An SMSF is a private superannuation fund that you can manage by yourself, rather than having it managed by a superannuation provider.
Your SMSF can have up to four members, all of whom are also considered trustees. If the fund has more than one member, each trustee will equally be responsible for the decisions made about the fund as well as its compliance with relevant laws.
The purpose of an SMSF is to give the member more control over their superannuation by allowing them to decide:
- how much money is paid into it; and
- where and how much of it is invested.
One of the benefits of being in control of your SMSF is that you can use it as a vehicle to buy an investment property.
What Are the Costs Associated With an SMSF?
There are various factors to consider when deciding to opt for an SMSF. One crucial factor is cost.
There is a wide variety of costs associated with starting up the SMSF, as well as with managing it each year. It’s highly recommended that you consult industry professionals such as accountants and lawyers to ensure that you are meeting the compliance regulations.
Costs can include:
- start-up fees which include the costs of obtaining a trust deed;
- legal fees;
- advice fees;
- stamp duty;
- bank fees;
- Annual management fees such as the SMSF levy collected by the Australian Tax Office (ATO), independent audit fees as well as the costs used to produce a tax return; and
- Investment management fees.
According to a 2017 report published by the Australian Securities and Investments Commission (ASIC), the average cost of running an SMSF (valued between $200,000 and $500,000) amounted to 3% of the funds’ balance.
In 2019, Carey’s SMSF had a total balance of $360,000.
In order to determine what her average annual fees would cost, she used the expense ratio recorded by the ATO:
$360,000 x 0.037 (or 3.7%) = $13,320
Note: this is just an average fee calculation proposed by the ATO based on research statistics provided by ASIC.
What Are the Laws Around SMSF Compliance?
SMSFs are required to comply with Australian superannuation legislation. Most importantly, the SMSF (as with all super funds), must be set up for the sole purpose of providing retirement benefits to its members.
Trustees (members) are consequently responsible for ensuring that their SMSF satisfies the ‘sole purpose test’ and that it complies with obligations proposed by the legislation, such as:
- developing an investment strategy and acting per that strategy;
- in preparation of the investment strategy, members must consider taking out appropriate insurance cover for each member;
- only accepting contributions to the SMSF from the members:
- monitoring the total SMSF balance and transfer caps;
- appointing a registered auditor to complete the annual audit;
- maintaining the necessary administration and record-keeping;
- ensuring the member has met a condition of release before they can withdraw from their SMSF; and
- lodging the SMSFs yearly tax return with the ATO.
If members fail to fulfil their responsibilities, the ATO is empowered to impose various penalties.
What Factors Should You Consider Before Buying a Property With Your SMSF?
If you are considering purchasing an SMSF property, you should take note of the following factors, namely that:
- The SMSF property can’t be owned for the purpose of living in it. In other words, you can’t rent the SMSF property, nor can you personally live in it.
- The above rule similarly applies to any related parties and other trustees of the SMSF.
- You can’t acquire the SMSF property from any related party or other trustees.
Brad and Susan Locke are trustees of an SMSF.
After doing thorough research and consulting with an advisor, they have decided that they would like to purchase an investment property using their SMSF.
Susan’s brother, Jacob, is currently selling an investment property that he owns on the Gold Coast.
However, for Susan to comply with the regulations, she can’t purchase Jacob’s investment property because the SMSF can’t buy a property owned by anyone related to the trustee.
While purchasing residential property poses some limitations, commercial property, on the other hand, allows for some more flexibility.
A commercial investment property can be leased to a more extensive list of tenants, provided that it’s solely used to conduct business. For example, your SMSF fund can be used to purchase the property from which you run your business.
Borrowing To Purchase Your SMSF Property
It’s possible to borrow money when buying an SMSF property. However, strict conditions govern the lending process.
Borrowing money must be done in terms of a limited recourse borrowing arrangement (LRBA). LRBA involves establishing a separate property trust to hold the purchased investment property on behalf of the SMSF.
While the property is held outside the actual SMSF structure, any return on investment gets added to the fund, and any expenses incurred from the property are deducted directly from the fund.
All loan repayments are similarly made through the SMSF. If the SMSF fails to meet the repayments; the bank can only access the investment property held in the separate trust as recourse. No other assets belonging to the SMSF will be affected.
You should recognise the following vital factors if you’re considering borrowing money to purchase an SMSF property:
- generally, the SMSF fund needs to have an existing minimum balance of $120,000 to be able to buy property;
- you will need to make an annual contribution to your SMSF of at least $15,000;
- banks often charge a higher rate of interest on a loan obtained by your SMSF; and
- in most cases, banks require the SMSF to have at least 30% of the value of the property available to use as a deposit.
What Are the Tax Consequences of Buying an SMSF Property?
One of the benefits of purchasing an investment property with your SMSF fund is the tax breaks available to you as a trustee:
- You are only required to pay 15% income tax on the rental income from your SMSF property. This is well below the marginal tax rates, which could amount to 45%, depending on your income threshold.
- Investment properties that are held by the SMSF for longer than 12 months qualify for a capital gains tax (CGT) discount on the sale of the property. Your CGT liability will only be 10%. You can also further reduce your CGT liability by ordering one of our capital gains reports.
- Once you retire and the fund starts paying out your pension, any rental income or capital gains resulting from SMSF property will be tax-free.
- If you borrowed money to purchase your SMSF property, the interest payments are tax-deductible to the fund.
Can You Claim Tax Depreciation for an SMSF Property?
To make the most of the deductions available to your SMSF property, you should consider having a quantity surveyor draw up a depreciation schedule to ensure that you are maximising all your property depreciating claims.
To put it simply, an SMSF is a type of superannuation fund that you manage yourself as opposed to having a provider manage it on your behalf. This allows you the freedom to decide how you would like to manage your fund and what property you would like to invest in using the fund.
Further advantages include being able to borrow money to purchase an SMSF property and various tax breaks.
However, managing an SMSF comes with immense responsibility, so it isn’t necessarily suited for all individuals.
With the various complex and strict compliance regulations in place, it would be a good idea to seek qualified and experienced advice if you are considering investing in residential or commercial property through your SMSF.
If you’ve decided to purchase an SMSF property after consulting with an advisor, it’s vital that you make the most of the tax benefits available to you.
For example, members qualify to claim depreciation deductions on their SMSF property.
The Duo Tax team of quantity surveyors are registered tax agents who aim to help property investors make every dollar count. Whether you own a residential or commercial property, we have the expertise to help you make the most of your depreciation deductions.
Access our free depreciation calculator here to see what you can potentially claim on tax depreciation.
Alternatively, get in touch with one of our Duo Tax Quantity Surveyors today to see how you can maximise your tax return.