Self-managed super fund assets in Australia now exceed $557 billion which represents 30.1 percent of total superannuation assets under management. Former Prime Minister Paul Keating, the architect of Australia’s compulsory superannuation scheme, recently suggested that self-managed superannuation funds (SMSF) should be restricted from investing in residential property. “If I was Treasurer today, I would be looking very hard at the whole entitlement or availability of debt to SMSFs. They have gearing available to them and, of course, many of them are taking the option of buying residential property. It is making it nearly impossible for younger people, owner-occupiers, to afford to house themselves.”
The Australian Taxation Office’s 2013/14 annual report said limited-recourse borrowing arrangements, which allow self-managed super funds to gear into property, have more than tripled from $2.5 billion at the end of June 2012 to $8.7 billion at the end of June 2014. The latest Australian Taxation Office (ATO) SMSF statistics reveal real residential property represents 3.5% of the value of all assets held in SMSFs (with commercial property around 12%). While this level of residential investment has been consistent since 2009, the significant change has been the number of investors with an average of 1,200 new investors using their SMSFs to purchase residential property each year.
For many SMSFs, the risks associated with purchasing property are heightened if borrowing arrangements are not put in place correctly. If your SMSF breaches its compliance obligations, it is at risk of being deemed non-compliant and losing its concessional tax status. The trustees are also at risk of being personally fined under the ATO’s new penalty powers that came into effect on 1 July 2014.
Below we have summarised the top four issues regarding SMSFs and property investments:
1. SHOULD MY SMSF PURCHASE A PROPERTY?
The Superannuation Industry (Supervision) Act (SIS Act) requires trustees of SMSFs to ensure three elements are considered when making an investment; liquidity, diversification and cash flow. The risk for trustees investing in real property is non-diversification (putting all of the fund’s eggs in one basket) and the rate of return may be insufficient to meet the fund’s obligations.
In addition, a SMSF entering or already in pension phase must meet the minimum pension drawdown requirements. Will the rental yield meet pension payments and other ongoing expenses of the fund? The minimum pension drawdown increases over time from 4% at age 64 to 6% at age 75. This is a 50% increase in the draw down obligation. Can the rental yield cover a 50% increase in that timeframe? Another issue may be if a member wanted a lump sum payout instead of a pension, or indeed if a member were to die, is there enough liquidity in the fund?
2. I WANT MY SMSF TO PURCHASE MY INVESTMENT PROPERTY
A very common mistake is the expectation that an SMSF can purchase a residential rental property, holiday home or house from a member or someone related to a member. The property must be ‘business real property’ (a property used wholly and exclusively for business - whether carried on by the entity or not) and in most cases, a residential property will not meet the requirements to be ‘business real property’. A breach in related party investment rules attracts a penalty of up to 12 months in jail.
3. PROPERTY IMPROVEMENTS
A property purchased using money borrowed by your SMSF cannot be improved using any part of those borrowings. Not only that, a SMSF cannot borrow money to repair or improve an asset it already owns outright. A SMSF can, however, utilise its own money to improve or repair a property acquired with borrowings, so long as the improvements do not change the nature of the asset. For example, the trustees could not convert a residential property into a car park or build an investment property on a vacant block of land. A classic example would be where a SMSF borrows to buy a residential house on a large block of land with a view to future development. The fund would not be able to sub-divide the land or build another structure because the borrowing rules prohibit a change in the character of the asset until the loan is repaid.
4. THE RIGHT STRUCTURE
Common problem areas for SMSF trustees often relate to simple structural faults such as purchasing a property for a SMSF, but signing the contract in the individuals name, not the SMSF. Another example might be where there is a related party involved like a unit trust but the unit trust was not established before the property was purchased or the incorrect name is inserted on the contract or registered with the titles office.
These are simple but costly errors which can be avoided by seeking professional advice. Before you purchase an investment property, particularly within your SMSF, please consult with us.
For many SMSFs, the risks associated with purchasing property are heightened if borrowing arrangements are not put in place correctly. If your SMSF breaches its compliance obligations, it is at risk of being deemed non-compliant and losing its concessional tax status. The trustees are also at risk of being personally fined under the ATO’s new penalty powers that came into effect on 1 July 2014.
Below we have summarised the top four issues regarding SMSFs and property investments:
1. SHOULD MY SMSF PURCHASE A PROPERTY?
The Superannuation Industry (Supervision) Act (SIS Act) requires trustees of SMSFs to ensure three elements are considered when making an investment; liquidity, diversification and cash flow. The risk for trustees investing in real property is non-diversification (putting all of the fund’s eggs in one basket) and the rate of return may be insufficient to meet the fund’s obligations.
In addition, a SMSF entering or already in pension phase must meet the minimum pension drawdown requirements. Will the rental yield meet pension payments and other ongoing expenses of the fund? The minimum pension drawdown increases over time from 4% at age 64 to 6% at age 75. This is a 50% increase in the draw down obligation. Can the rental yield cover a 50% increase in that timeframe? Another issue may be if a member wanted a lump sum payout instead of a pension, or indeed if a member were to die, is there enough liquidity in the fund?
2. I WANT MY SMSF TO PURCHASE MY INVESTMENT PROPERTY
A very common mistake is the expectation that an SMSF can purchase a residential rental property, holiday home or house from a member or someone related to a member. The property must be ‘business real property’ (a property used wholly and exclusively for business - whether carried on by the entity or not) and in most cases, a residential property will not meet the requirements to be ‘business real property’. A breach in related party investment rules attracts a penalty of up to 12 months in jail.
3. PROPERTY IMPROVEMENTS
A property purchased using money borrowed by your SMSF cannot be improved using any part of those borrowings. Not only that, a SMSF cannot borrow money to repair or improve an asset it already owns outright. A SMSF can, however, utilise its own money to improve or repair a property acquired with borrowings, so long as the improvements do not change the nature of the asset. For example, the trustees could not convert a residential property into a car park or build an investment property on a vacant block of land. A classic example would be where a SMSF borrows to buy a residential house on a large block of land with a view to future development. The fund would not be able to sub-divide the land or build another structure because the borrowing rules prohibit a change in the character of the asset until the loan is repaid.
4. THE RIGHT STRUCTURE
Common problem areas for SMSF trustees often relate to simple structural faults such as purchasing a property for a SMSF, but signing the contract in the individuals name, not the SMSF. Another example might be where there is a related party involved like a unit trust but the unit trust was not established before the property was purchased or the incorrect name is inserted on the contract or registered with the titles office.
These are simple but costly errors which can be avoided by seeking professional advice. Before you purchase an investment property, particularly within your SMSF, please consult with us.
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