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Using your super to invest directly in property

Posted By Paul Rickard On In Property,Technical | No Comments

Improving auction clearance rates, record low interest rates and a sense that the property market is coming out of the doldrums are leading many SMSF trustees to think hard about using their super monies to invest in property.

Typically, SMSFs have invested in property indirectly through listed or unlisted property funds, or for those where the trustee own a business, by buying the trustee’s business premises. Purchases of investment property have represented only a very small proportion of overall SMSF assets. However, a change by the ATO in its interpretation in its treatment of “improvements”, together with improving market sentiment, have led to a strong pick up in investment property enquiries by SMSF trustees.

Let’s take a quick look at the advantages and disadvantages of buying an investment property in your SMSF.

Advantages

  1. Unlock your super money: Your super monies cannot be accessed (withdrawn) until you meet a ‘condition’ of release, which for most of us is not until age 60. However, you can use these monies to buy an investment property in the name of your SMSF. The super monies can be used as the deposit, or to buy the property outright. For keen property investors, using your SMSF is an alternative to buying property with your own money;
  2. Maximum capital gains tax rate is 15%: Because super funds are taxed at concessional rates, the tax payable on any capital gain will be considerably less inside your superannuation fund than if you own the property outside super. In fact, the following rates will apply:
    • If your fund is in accumulation phase and you have owned the property for less than 12 months, capital gains will be taxed at 15%;
    • If your fund is in accumulation and you have owned the property for more than 12 months, capital gains will be taxed at 10%; and
    • If your fund is in pension, capital gains will be taxed at 0% – tax free!
  3. Income on the property (net rent) is only taxed at a maximum rate of 15%: As with all superannuation investments, income is concessionally taxed – 15% in accumulation, 0% on assets supporting pensions. This is great for properties that are purchased outright, and for those that are positively geared.

Disadvantages

  1. Single asset risk: Property is a lumpy asset, and for many funds, the investment property may represent a considerable chunk of their super monies. They may be overly exposed to a single asset class – and perhaps more importantly – a single asset. Other asset classes such as shares may provide better risk-adjusted returns – and we can’t all “buy the worst house in the best street”. Like all markets, you need to know what you are doing;
  2. Transaction costs and liquidity: Transaction costs, such as stamp duty and the agent’s fee when you come to sell the house, are relatively high. Further, if you are planning to borrow to purchase the property, then super loans are relatively expensive to set up. You should count on:
    • To set up the bare trust for the property (ie the property custodian), around $2,500;
    • Loan application fees – some banks are still charging around $1,500 for a residential property application fee, although competition is bringing this down to as low as $500;
    • Bank legal fees – to review your SMSF trust deed and property custodian deed, typically around $1,500;
    • A valuation may be required (you pay the valuation fee); and
  3. Negative gearing makes no sense: As your SMSF only pays tax at a maximum rate of 15%, it is not the most tax efficient vehicle for a negatively geared property. If the sum of interest expenses, rental expenses, repairs and depreciation exceeds the rent, then the effective deduction on the difference is 15% inside super compared to up to 46.5% outside super.

Two things you can’t do

Using your SMSF to buy an investment property can be a pretty effective strategy. Last year, the ATO confirmed a change in the rules that means that for a property subject to a super loan (‘a limited recourse borrowing arrangement’), other monies inside or outside your super fund can now be used to improve the property. Potentially, you can “buy the worst house in the best street, do it up, and then when you are in pension phase, sell the property free of any capital gains tax”.

That’s the strategy – buying, potentially improving, holding, and selling free of any CGT.

However, there are two things you can’t do when it comes to investment property and SMSFs. Unfortunately, some of the property “spruikers”/real estate agents/ buyer’s agents don’t understand the rules. These are:

  1. You can’t purchase the investment property from a ‘related party’. Under the super rules, this is pretty exhaustive – a related party to a member includes any lineal descendent (husband/wife/brother/sister/son/daughter/aunt/uncle etc), or a company or trust controlled by the member; and
  2. If it is an investment property, you or a related party can’t rent the property from the fund. In 99% of cases, this will cause the fund to breach the ‘5% in-house assets’ test. You will need to find an external tenant.

Important: 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. Consider the appropriateness of the information in regards to your circumstances.

Also in the Switzer Super Report