Investing in Property in Western Australia with Your Self Managed Super Fund

On Wednesday we provided the first five tips when deciding to invest in property in Western Australia with your Self Managed Super Fund. If you missed that article, you can view it here.

Below are the remaining five tips.

6. SMSF can borrow to buy property

In September 2007, S.67(4A) was inserted into the Superannuation Industry (Supervision) Act 1993 (SIS Act), under which SMSFs became eligible to borrow in order to acquire a property as long as they complied with a number of provisions.

“Recent changes to superannuation legislation now allow SMSFs to borrow to acquire assets including residential and commercial property to support their investment strategies subject to meeting a number of requirements,” says Hasib.

Under the new guidelines an SMSF borrows funds to acquire an asset, for example a residential and / or commercial property. A separate trust is established to hold legal ownership of the property on behalf of the SMSF. These trusts are generally referred to as security trusts or warrant trusts. A loan is then arranged to meet the balance of the purchase price (plus costs) that the SMSF is not providing. The SMSF becomes the beneficial owner and manages the property as it would any other real estate investment.

“The loan is a limited recourse loan and the property asset is used as security. In the event of a loan default, the lender only has recourse to the residential and / or commercial property. They cannot claim on any other SMSF assets,” says Hasib.

7. Family and associates are not allowed to stay in SMSF residential assets

SIS law is very strict about residential property owned in SMSFs as an investment, including holiday property investments. They simply cannot be used by members or any related parties. Members including their family, associates and business partners are restricted in using the assets of the fund unless they are business real property, and then only if they are solely used for business purposes by a member or related party, and only where commercial rates of rent and lease terms are being provided to the SMSF which owns the asset.

8. SMSF allows you to buy a retirement home

In retirement, people need an income, and a place to live. One of the most fundamental superannuation questions is whether a member can acquire a residential property asset in their SMSF that will eventually become their retirement home.

According to Hasib there are ways this can be achieved in a SMSF structure.

A couple aged 50 might acquire an ideal investment property on the beach using their SMSF, either with cash, or with some allowable borrowings. The property in the SMSF is rented out, and the rental income plus contributions (any salary sacrifice plus any employer contributions) flow to the SMSF, less the 15% contributions tax. As cash builds up within the SMSF, the trustees use this money to pay off the loan that funded the original purchase. After 10 years they decide the sell their primary residence and pay no capital gains tax. They may then proceed with their plans to purchase the property off the SMSF (providing tenants have left).

If just before they purchase the property off the SMSF, they convert the fund into an allocated pension, as assets sold in pension phase pay no capital gains tax (CGT), then there will be no CGT on either property (note stamp duty is still payable). Purchase proceeds are in the superannuation environment paying them tax free income (assuming 60 years of age and over) and they get to live in the dream beach-front home, purchased 10 years ago using their superannuation, in their retirement.

9. SMSF benefit in the super tax environment

As with all investments in a complying SMSF, because contributions and investments in the fund are preserved until retirement, they enjoy the beneficial superannuation tax regime.

“Just like negative gearing in an individual’s name, the SMSF would benefit from the same tax benefits, that is, tax deduction for the negative component of the interest, and depreciation,” says Hasib. “However the biggest benefit is CGT. Should the fund hold the asset longer than one year and then decide to sell it then CGT drops from 15% of the gain down to 10%, and if sold in pension phase (generally over 55 years of age) CGT is 0%.”

The beneficial superannuation tax environment means that income and capital gains earned from a property held in a SMSF provide greater reinvestment value, being the difference between a member’s individual tax rate on income and capital gains, less the tax rate they pay within the superannuation environment.

10. SMSF must satisfy the law

“It is crucial to seek professional advice,” says Hasib. “The SIS regulation is complex and requires careful consideration before implementation. One also needs to take into consideration the appropriateness of starting a SMSF and weigh up the costs relative to the potential gain.”

It is mandatory that trustees, or would-be trustees, understand the law and spirit of the governing superannuation legislation (SIS). However as trustees of a superannuation fund they must also understand their obligations under the: Corporations Act; and the relevant taxation laws.

For trustees of SMSFs there are no excuses for not complying with the law, and the rules outlined in the trust deed and the investment strategy. Trustee obligations to the members of their funds are regulated by ASIC and the ATO. Penalties for not following these rules can include: your SMSF becoming non-compliant and losing its preferred tax status; the trustee(s) becoming disqualified to act as trustees; prosecution under law; and a range of significant penalties including imprisonment for criminal breaches of the law.

Trustees should keep informed of their duties and where confused: consult the ATO website www.ato.gov.au; or obtain an explanation from an accountant, financial adviser or a lawyer.