One of the differences between an industry or retail super fund and investing in a self-managed super fund (SMSF) is the ability to invest in both residential and commercial property. There is also the ability for an SMSF to borrow to have property as part of its investments. There was a lot of speculation, as a result of the Financial Systems Inquiry, that the government would stop borrowing by SMSF’s but nothing was included in the budget and all has gone quiet on that front. Property seems to be so attractive as it fuels Australians love for the bricks and mortar. With all things super though, there are some important things to take into account if you are thinking of this type of investment for your super fund. It’s about what’s great about borrowing (the good), what’s not so good (the bad) and what the risks are (the ugly).
The Good
Borrowing to buy property in an SMSF is a great, low tax alternative to otherwise buying property, personally or even through a company. Any net income is taxed at only 15%, if your super fund is in accumulation phase, or zero if the property is supporting the payment of an income stream from your super fund in the pension phase. If you held it personally, it would be taxed at your marginal rate of tax, or at the company rate of tax if held through a company, both of which would be higher than 15%.
The Bad
There are the inevitable rules surrounding borrowing within an SMSF. The Superannuation Industry (Supervision) Act 1993 directly prohibits self-managed super funds from borrowing so a separate entity called a Bare Trust has to be set up to hold the property on behalf of the SMSF. This separate trust is called a bare trust because it can barely do anything but hold the property in trust (on behalf) of your SMSF. The SMSF pays all costs and collects all revenue. The trust deed of the bare trust should note that the trustee of the bare trust will transfer ownership of the property to your super fund once the loan has been repaid.
Borrowing to buy property through an SMSF can only be done through a limited recourse borrowing arrangement or LRBA which means that the only recourse that the bank or other lender has, in case of default, is the property itself. They cannot go after any other assets in the SMSF.
As you can imagine with these additional administrative burdens, there are inevitable costs, both in terms of time and money, involved in setting up the separate company structure for the bare trust, producing the trust deed and other administrative requirements. Banks may also charge extra in the loan application because they will have to look at all the various trust deeds and other documentation to ensure that everything has been put in place correctly. They will want to check that there will be minimal risk for them in the event that your super fund defaults on the loan and they have to repossess the property. This may involve the requirement for personal guarantees to be given and a higher percentage of the purchase price to be borne by the SMSF.
Another downside is that any equity that your super fund has in the property can’t be used to borrow to buy further properties, either inside or outside your super fund.
The Ugly
The SMSF has to make the repayments on the loan, so you need to be confident, as trustee of your super fund, that your super fund will be able to do that. There are not only loan repayments, there are also the other expenses that have to be met like rates, insurance and land tax. And you need to be able to maintain the income stream from the property. What if you can’t rent the property out? Is there enough cash in your super fund to keep paying the loan? Your super fund’s ability to repay the loan is one of the factors that the bank or lender will look at when considering your super fund’s loan application.
But coming in at number one of the BIG, BIG risks of borrowing is the fact that, if your super fund breaks any of the rules, then it may be required to sell the property. This could be at a substantial loss and, because your super fund has contravened the law, it could be liable to penalties. Imagine what that would do to your super fund balance?
Audr
ey Dawson is Director of Super Confidence and author of
“Hol
y Crap! Where’s My Super Gone?!Self-managed Super Made Simple”
