Shane, a 34 year-old self-employed tradesman, asked me an interesting question the other day on Peter Switzer’s The Super Show on 2GB and MTR.
During the GFC, Shane and his wife watched their super lose a lot of money and they decided they would be better off ignoring the super system. Instead, they bought several residential investment properties with which they plan to fund their long-term wealth-creation needs. The properties are geared, but the rent is paying down some of this debt as well as meeting their other costs.
“There’s nothing as safe as houses,” Shane said. Nevertheless, he wanted to know if their strategy was a good idea.
On the surface Shane’s question strikes at the heart of many an emotional view about where to invest our money. Some of us will passionately believe, perhaps through positive personal or family experience, that Australian property is a sure fire way of building wealth.
Other investors will think that other investment sectors such as equities are the way to go because property can only be traded in large lumps and is difficult to manage.
Personally, I have no strong opinion either way. All investments have their pros and cons.
The reality, however, is that it’s inappropriate to compare property and super. I know it’s a common point of discussion, but it’s not a reasonable comparison.
Why? Property is an asset class much the same as shares are an asset class. On the other hand superannuation is an investment structure that holds asset classes. Your super fund can invest in property if it wishes to do so.
So how can I help Shane make an informed decision? Well an important issue with all investments is to know the costs of buying, holding and selling those investments, especially when it comes to the tax implications.
Property
Typically residential property is expensive to buy and sell. There are many transaction costs, like legal fees, agent costs, architectural inspections, stamp duty and so on.
The tax system potentially provides a range of tax concessions for investing in residential property – building and depreciation allowances as well as the ability to claim various costs as tax deductions. Typical examples may include repairs and maintenance, but not improvements, as well as interest costs on any borrowings.
Importantly, there is no limit to the size of the tax concessions. For example, your interest tax deduction is unlimited and this in itself creates a risk for some enthusiastic investors. Many property investors rely on these tax concessions to make the investment work from a cash flow perspective. That is, if they didn’t get the tax breaks, the investment wouldn’t work for them.
Another risk is that you might borrow too much. If there is a sharp spike in interest rates or a tenant can’t be replaced, then many residential property strategies unravel.
When a property is sold, if it’s been held for more than 12 months then only 50% of the net capital gain is subject to capital gains tax (CGT). If your marginal tax rate is 46.5% then this means you would be paying 23.35% CGT.
Super
There are a number of tax concessions for making super contributions, typically tax deductions, but there are tight restrictions on these. The Government Co-contribution is also available.
Super is subject to a flat tax of 15% for non-pension assets and 0% for assets supporting a pension, and after age 60, super becomes fully tax-free inside and outside the super fund. Realised capital gains in the 15% tax part of a fund are taxed at 10%.
Even so, super can be very expensive because many costs are hidden through percentage of asset fees.
As you’ll all be aware, super is locked away until retirement, whereas property investments held directly can be liquidated. Access to you investments prior to retirement may be an important consideration for you when determining what to put in or keep out of super.
But what is often not known is that most property concessions mentioned are available to a self-managed super fund and it’s possible to borrow money in a super fund and buy a property (read, How to use super gearing to buy property [1] and Top 5 super gearing traps [2].
If you’re interested in holding property in your super fund, remember to consider your fund’s investment strategy. Property investments often don’t work for super pensions without very careful planning. This is because pensions demand income be paid and this means that ultimately the asset will have to sold, so your investment time frame needs to be considered.
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.
Also in the Switzer Super Report
- Paul Rickard: Should you buy Origin Energy’s hybrid notes? [3]
- JP Goldman: Which high-income ETF is best for your SMSF? [4]
- Charlie Aitken: Two stocks to buy today [5]
- Peter Switzer: Warren Buffett and 18 high yielding stocks to buy [6]
- Andrew Bloore: Your responsibilities as an SMSF trustee [7]