In the past, media has focussed on the risks of investing in geared property by self-managed superannuation funds (SMSFs) and whether it is really the right long-term decision for a member’s retirement. It can be the right choice for some but it’s not for everyone.
Opportunities come with risks which are the same as any individual’s decision to make a personal property investment. There are however some risks which are unique to SMSFs.
SMSFs and Property Investments
There’s no question that property can reward investors with capital growth and steady rental income. However, when it comes to property and SMSFs the investment needs to be carefully considered. This applies especially if borrowing is involved, due to the potential demand on the fund’s cash flow that is provided by a steady stream of contributions. In hard times if the property cannot be leased out, the cash flow from contributions can be used to pay for investment expenses.
The advantage of an SMSF investing in property is the generous tax concessions given to super. Rent from the property investment will be taxed at 15% and capital gains from selling the property can be as low as 10% while saving for retirement. If you decide to take a pension from your SMSF any rent and capital gains can be tax-free (subject to transfer balance caps of up to $1.6m per person). On the other hand, because of these low tax rates the benefits of negatively gearing (expenses of the property are greater than the rent received) an investment property can be less than if you did this as a personal property investment.
Also, insurance and whether a large illiquid asset like property will suit the SMSF member’s needs for their retirement must be considered. Selling an illiquid asset like a property can also take time and involve higher costs than liquid assets such as ASX shares, which can normally be sold very quickly. The sale of the property may also result in a large inflow of funds all at once, rather than a steady stream of income. This needs to be managed carefully if an SMSF is to pay you a pension.
An SMSF can invest in residential and commercial property either directly if it is ungeared or by using a limited recourse borrowing arrangement where it borrows to purchase a property that is held in trust on behalf of the fund.
Limited Recourse Borrowing Arrangement (LRBA)
SMSFs are allowed to borrow to make an investment under some very strict rules which must be followed without exception. These arrangements are known as LRBAs and are most commonly used by SMSFs to invest in property. LRBAs involve complex rules and structures and require extensive legal documentation and bank loan approvals.
LRBAs essentially limit a lender’s rights against the borrower to the property that secures the loan. This means if an SMSF borrows to buy a property via an LRBA and the SMSF is unable to pay the loan, the lender can only seek compensation by taking possession of the property alone and is not able to access any of the fund’s other investments.
The LRBA rules limit the types of properties that can be acquired and what can be done to the property. Properties need to be single investments and limits apply to the types of, and how repairs and improvements can be made to the property. These rules are very technical and complex.
Does property suit your fund?
If you are considering purchasing an investment property within your SMSF and require assistance or guidance to navigate the complexities of structuring the transaction correctly, please give us a call to arrange a time to meet so that we can discuss your particular circumstances and the suitability of this strategy.
Source: SMSF Association
To book a no obligation appointment with our SMSF Advisor please call (03) 6344 3899 or send us a message below:
The article is of a general nature only and is not to be taken as recommendations as it might be unsuited to your specific circumstances. The contents herein do not take into account the investment objectives, financial situation or particular needs of any person and should not be used as the basis for making any financial or other decisions. This disclaimer is intended to exclude any liability for loss as a result of acting on the information or opinions expressed.
Technical Papers contain general advice only and are prepared without taking into account particular objectives, financial circumstances and needs. The information provided is not a substitute for legal, tax and financial product advice. While the SMSF Association believes that the information provided is accurate, no warranty is given as to its accuracy and persons who rely on this information do so at their own risk. The information provided in this bulletin is not considered financial product advice for the purposes of the Corporations Act 2001.