A self-managed super fund, or SMSF, allows you total control over the investments made with your retirement money. The investments can be made in investment property, shares, term deposits, or other allowable investments.
The Australian Taxation Office (ATO) estimates that there are 598,000 SMSFs nationwide as of June 2021 with more than 1.1 million members.
Listed shares made up 31% of the estimated $822 billion total asset value held by SMSFs. These were followed by lower-risk cash and term deposits (21%).
Real estate only accounts for about 13% of the SMSF portfolio. Even though this is lower, real estate can be a good investment for your SMSF.
What is a Self Managed Super Fund (SMSF)?
According to MoneySmart, a Self Managed Super Fund (SMSF) can be simply defined as “a private fund that you manage yourself.”
An SMSF can have up to six (6) members, and each member must be a trustee. As a result, each fund member shares responsibility for the fund’s choices, decisions, and adherence to applicable regulations.
Members of the fund cannot be an employee of another member of the fund unless those members are related.
Additional responsibilities of trustees include:
- Adopting an investment strategy that will meet the members’ retirement needs and that is within the risk tolerance levels.
- Possessing the required skills and knowledge necessary to make financial and investment decisions,
- Maintaining all documents for annual accounting and audits.
- Plan and arrange personal insurance for fund members.
- Trustees cannot receive any remuneration for their services as a trustee.
Superannuation is essentially a retirement savings account in which your employer is required to contribute a certain minimum amount by law. You cannot have access to the funds until you reach the “preservation age.” The preservation age varies from 55 – 60 years old depending on which year you were born.
An SMSF is designed to allow you more control over investments in your super.
Managing a Self Managed Super Fund can be a huge undertaking that takes a lot of time, work, and effort.
Additionally, an SMSF can come with a lot of costs. These include fees for hiring experts like accountants and financial advisers to help you manage your fund.
SMSFs are regulated by the Australian Taxation Office (ATO). The ATO helps guard the retirement income system. They do so, by making sure that SMSFs follow rules outlined in the super and income tax legislation.
Benefits of SMSF
Without a doubt, setting up an SMSF will allow you to have greater control of your superannuation. Advantages of SMSFs include:
- More control over where and how your super will be invested
in a wider range of investment choices.
- Certain personal assets can be transferred into your SMSF or purchased by your SMSF.
- Able to combine family assets to decrease overall fees.
- Providing you with a sense of security as you are able to actively participate in the management of the fund.
- Able to implement tax planning strategies flexibly
- More flexible options in retirement planning and estate planning are available
- Able to accept contributions from all sources including:
As a member and trustee of your very own self-managed super fund, you are in control. You are involved in the decision-making processes, and you are able to operate the fund’s bank account. The bank account contains contributions, rollovers, and investment incomes.
The money in the account can be invested accordingly. It is used to pay for fund expenses such as taxes and accounting fees. In addition, tax-deductible insurance policies can be acquired to protect yourself. When you reach retirement age the fund can provide you with a pension.
Can you buy residential property with your Self Managed Super Fund?
The answer is yes, it is possible for an SMSF to buy residential real estate property. Before making the decision to buy property, the following limitations must be considered:
- Residential property acquired through the SMSF cannot be occupied or rented by a trustee or anybody related to the trustee.
- A property owned by a trustee or a person related to the trustee cannot be purchased by the SMSF.
- The acquisition of the property must pass the “sole purpose test,“ which states that the acquisition must only be for the purpose of maximizing members’ retirement savings.
The sole purpose test’s goal is to make sure that the SMSF is only used to maximize super benefits. For members upon retirement or their financial dependents in the event that the member passes away prior to retirement.
Can you buy commercial property within SMSF?
The same requirements, such as the sole purpose test, apply. This is when purchasing commercial property as they do when purchasing a residential property.
It is common amongst small and medium-sized businesses (SMEs) to purchase commercial real estate through an SMSF and then the business lease while paying the Self Managed Super Fund rent expenses.
Commercial investment rental arrangements must be managed strictly on an “arm’s length basis” and rented at market rates.
In addition to the sole purpose test, there are a number of requirements that must be adhered to, including the ones listed below:
- The lease’s terms must be either market-value-based or commercially competitive. By law, you cannot lease the property to your business at significantly lower rates compared to the market.
- Value the property regularly in order to be certain that the rent you are paying reflects the current market price.
- Rent must be paid up to date. You cannot miss payments or be late. Your lease will not be valid if you don’t adhere to these guidelines.
It is not worth breaking the law because the ATO oversees SMSFs and frequently audits them to ensure compliance.
Can an SMSF borrow to buy a property?
You can use your SMSF balance and deposit to obtain a loan for the rest to purchase real estate. However, doing so is complicated and subject to stringent regulations.
Loans made to the Self Managed Super Fund must be made through a limited recourse borrowing agreement (LRBA). In order to limit the lender’s options to access your SMSF balance as security, a separate trust, and trustee—known as a custodian—must be established. This is to reduce the risk to other fund assets.
The lender will try to recoup its losses by seizing assets if the SMSF is unable to make loan payments and falls behind.
The assets inside the SMSF are typically protected from the possibility of being repossessed by the lender. This is so because the property is in a distinct trust from the SMSF. As a result, the lender cannot typically pursue the assets within the SMSF.
You can use the money you borrow from an LRBA towards the purchase of the property. As well as maintenance and repairs of the property.
Maintenance and repairs include modifications where you are restoring the fixture to its original state.
Therefore, you may use borrowed money to replace a worn-out kitchen tabletop with a new one.
On the other hand, you cannot use the money to make major improvements. These include things like extensions and granny flats to the property. Going back to our kitchen tabletop example stipulated above. You cannot use the borrowed money to pay to extend that bench.
Tax implications of buying property through SMSF?
One of the main reasons why people buy property in SMSF is the tax advantages.
Just like an individual tax return, the fund’s taxable income is equal to the fund’s gross income less any allowable deductions.
Whilst the fund is in the accumulation phase, the tax on taxable income is only 15%, which is the lowest tax rate. The fund becomes tax-exempt when it reaches the pension phase.
The 15% tax rate only applies to compliant funds; if you are a non-complying fund, which means you have either received a notice of non-compliance or are not an Australian resident, you may be subject to a 45% tax rate.
If the property was purchased with a loan from an SMSF, you may also be eligible for tax advantages. If your expenses outweigh your rental income, your taxable loss may be carried forward each year to offset future taxable income. Interest payments on the loan may be tax-deductible to the SMSF.
What to watch out for when purchasing a property in SMSF?
When planning to purchase a property through an SMSF, there are a number of variables you need to take into account. In addition to the numerous restrictions, requirements, laws, and red tape.
These should be taken into account as part of your investment strategy before investing in real estate.
When an SMSF gets into the pension phase, it is legally required to pay the minimum pension amount. This amount increases yearly as the trustees get older. Because of this, it’s crucial for an SMSF to have a variety of assets. These include but are not limited to shares, cash, or real estate. As a result of this diversity, other assets like cash can still fund the requirements of minimum pension whilst classes like shares and property continue to grow.
There is a huge responsibility of compliance that comes with purchasing a property through an SMSF.
It is a significant commitment to audit your SMSF annually as required by law. In addition, the ATO also frequently audits SMSFs to make sure they are operating within compliance guidelines.
Of course, you can outsource many of the duties necessary to be compliant. However, the cost could also be on the high end. Compliance and SMSF work hand in hand, which is a large part of what makes SMSF property investment so intimidating.
Due to the high costs involved, investors are frequently deterred from investing in SMSF properties. For some, it can be expensive to hire a team of accountants, and other professionals to make sure everything is completed on time. Costs may comprise of:
- upfront set-up costs
- advice fees
- legal costs
- stamp duty costs
- bank charges
- ongoing charges for property management and maintenance
Compared to industry funds, most SMSFs pay a lot more in fees. The expenditure ratio is the average annual total cost of managing an SMSF. Which is expressed as a percentage of the fund’s balance. In 2017, an APRA-regulated fund’s typical expense ratio was 0.8%. According to ASIC, the expense ratio for an SMSF with a value between $200,000 and $500,000 was around 3%.
At times you might choose or be forced to top up additional funds into your SMSF. This can happen when there is insufficient liquidity in your SMSF to meet the regular loan repayments and other fund expenses.
If that is the case, keep in mind that the additional funds you top up with will be counted as super contributions. Therefore you will not be able to access the money until you reach retirement age.
As a result, it’s crucial to approach the process of purchasing a property with a specific and well-defined investment plan. Which includes a detailed cash flow projection.
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Advantages and disadvantages of using an SMSF to purchase property
Buying property in SMSF can be a great method of diversifying your retirement savings.
However, it frequently comes with costs and compliance obligations. A summary of its benefits and drawbacks can help you decide if it’s right for you:
Tax advantages: Buying real estate through an SMSF may give trustees a sizeable tax reduction. In the accumulation phase, super funds, including SMSFs, are typically taxed at 15%. A rate far lower than that of the majority of Australians.
In addition, any capital gains on the property may be taxed at a reduced rate of 10%.
LRBA: Limited recourse borrowing agreement (LRBA) can let you use borrowed money from the bank to acquire investment property through an SMSF as well as make renovations if need be whilst minimizing the risk to other assets in the fund.
More financial control: The sole purpose test requires you to deliver the optimum financial outcome for your retirement. Leasing the commercial property back to your business can provide your business with stability and control.
Time: Managing an SMSF can be quite difficult on its own. When you add the difficulty of buying and managing a real estate property, things can get considerably trickier.
Of course, you can hire professionals to help you. However, you may still need to put in a lot of work yourself. Your fund can experience compliance issues if you lack the time management, skills, and financial expertise to handle the process.
Costs: In addition to usual SMSF expenses, investing in real estate typically entails a wide range of fees. In addition, you’ll likely spend money on accounting services on an ongoing basis. Who will assist you through the entire process.
Risks: Investing in real estate carries some risk, and purchasing property through an SMSF may present additional risks. It can be a complicated and frustrating experience due to the level of compliance involved, as well as legislative requirements and obligations.
The process of starting and purchasing real estate through an SMSF can be laborious and challenging.
If you currently have an SMSF, you’re probably already aware of the difficulties that might result from such a complex financial setup.
For some, whether for asset diversification or for business use, investing in SMSF property can be a highly flexible plan.
On the other hand, and for others, the drawbacks of investing in real estate in SMSFs outweigh the positives due to potential liquidity and cash flow requirements.
Regardless of the path you choose, maintaining compliance is crucial, which frequently necessitates a team of experts.
WatuDaily has created this information, is provided solely for informational reasons, and should not be regarded as tax, general advice, or personal financial advice.
Before making any decisions, WatuDaily advises seeking personal financial advice from a licensed financial adviser with expertise in superannuation.