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Investing with Super

Investing with Super

How much do you need in $$$$?

You generally need between a 20- 30% deposit plus costs, depending on the type of trustee for the SMSF. However the general rule of thumb is that it is only worthwhile to have a SMSF if the total super is around $150,000 due to the various setup and maintenance expenses.

 

What sort of property can you buy?

Any property purchased using a SMSF must satisfy the sole purpose test. Whereby the fund/investment decisions for SMSFs must be made for the sole purpose of providing retirement benefits to its members (at retirement time). Any investments that generate/offer pre-settlement benefits to members or its associates are a violation of the test. Violation may result in the trustee facing civil & criminal penalties and the SMSF will lose its tax concession.

Any investment made also needs to be an arm’s length transaction and make commercial sense to benefit the SMSF.

SMSF property rules:

– must meet sole purpose test

– must not be acquired from SMSF members or their related parties

– must not be lived in by SMSF member or their related parties

– must not be rented to SMSF member or their related parties

An exception is that a SMSF can potentially buy your business premises so that the business pays rent directly into the SMSF at market rate. Capital gains may be payable on the sale to the SMSF.

There is essentially no restriction on what properties you can buy under ATO rulings. The ATO is more concerned about the transaction rather than the type of property.

 

How does it work re negative gearing? Can you negative gear within a super fund and how does this work?

You can but it isn’t recommended for the following reasons. Firstly, losses are offset against other superfund income but the maximum tax rate is only 15%. It would make a bigger difference for your personal income which could be taxed as high as 45%. Secondly, with the tight rulings on improvements it can be difficult to increase the income generated to transform it to positively geared property. Lastly with the generous tax rate on income negative gearing is a wasted opportunity, so the incentive should be to try and make a profit on rent.

 

 What can’t you do?

The limited recourse borrowing arrangement (LRBA) is the instrument that allows SMSF to borrow from the banks. The ATO has strict rules on what qualifies under LRBA. If it does not meet the requirements it can still potentially be done, however it must be funded using cash in the SMSF. Therefore bank policies are aligned with LRBA rules.

LRBA rules:

– Repair and maintenance of the property is allowed but improvements are not (I.e. You can borrow funds for repairs but cannot for an extension. However if the SMSF has enough cash you can add the extension using that money).

– You can borrow funds to retain the asset’s identity but any changes that result in a different asset is not acceptable (only applicable if there is an existing LRBA in place).

Example, the original asset is a block of land. By subdividing, the identity of the asset has changed. The same applies if you build a house on it. Therefore it cannot qualify under a LRBA. (However if land was originally purchased by cash, then it is not bound by a LRBA or construction can be done using the SMSF’s cash). Another example is option to buy a house. The option can be sold to another party as an option but the option itself cannot be realised by SMSF as it changes the identity of the asset i.e. From option into an actual property.

– Single asset (as limited recourse must be limited to 1 asset). Examples of single asset include:

–  If the property was originally presented as house and land package, then it is 1 single asset and identity as house on land.

– Off the plan (property was purchased as a single title although the title may not be issued yet, I.e. Still under master title)

 

If you want to renovate/subdivide/develop – what are some of the problems you might face?

Due to the restrictions of LRBA, some of the problems could be:

Renovate: depends on the work to be carried out and whether it is classified as maintaining and repairing OR improving. If it is the former, it can be financed. If it is the latter, a potential problem could be cash flow/capital as the renovation will most likely need to be funded from SMSF cash, not financed.

Subdivide & Develop:

There are two main issues:

1) As both subdivision and development changes the identity of the asset and results in multiple assets, it will not fall under LRBA rules. Therefore it cannot be financed and thus requires a lot of capital in SMSF.

2) You can be deemed as running a business as a developer out of your SMSF. This could result in loss of tax concession for the SMSF.

 

What are the pros?

The main attraction to SMSFs is the associated tax benefits. The maximum tax rate on capital gains is 15%, reduced to 10% after 12 months, and is eliminated once you are in the “pension phase”. This alone could save you tens of thousands, even hundreds of thousands in tax. It is a similar story for rental income with 15% capital gains tax being the maximum and none at all during pension phase.

 

The cons?

As well as the higher deposit and lower LVR required by many lenders there is also the drawback that the equity cannot be accessed to borrow more funds. As a result you cannot use the property to build your portfolio.

Everything must be transacted at “arm’s length.” You cannot purchase a property from a member or a relative of a member and further it cannot be used or rented by a member or their associates.

Essentially there are strict rules to follow and any mistakes in following them will be costly.

 

When can you sell the property and realise a profit? 

A SMSF can sell at anytime however profits go back into the SMSF which can only be drawn once members reach preservation/retirement age. If you were born before 1 July 1960 that age is 55 and anyone born after 1 July 1964 has a preservation age of 60 with the ages progressively increasing by a year for the period in between.

 

What sort of property should you buy with super?

Due to the restrictions on improvements avoid anything that would be classified as a renovators dream. Instead it is recommended the property should be new so that maintenance and improvements will be less likely to be required. Being a long term strategy the main objective should be location with strong capital growth prospects. As negative gearing is not considered worthwhile in SMSF, due to the tax concessions, you should also try and find a property with a high rental yield.

 

What else do you need to know re using super to buy property?

Investors need to be aware that the cost to purchase the property is significantly higher due to setup costs for the LRBA required structure (bare trust etc), more bank fees and higher interest rates (no propack applicable).

 

What are the risks?

Loan repayments have to be made from your SMSF property. So if you don’t have the necessary cash reserves you could be in trouble if your tenant stops paying rent. This becomes even more relevant once retired as no are no longer earning a steady income.

 

Is it worth using super to buy property?

It really depends on the investor and their strategy. If you do plan to use SMSF it is recommended you do so as early as possible from your planned retirement as you have a steady cash flow to deal with any tenant problems. This also allows the property a greater opportunity to grow, making sure you can take full advantage of the tax benefits so you can live your latter years doing what you had always dreamed of.

 

Investing using super can be complicated but our expert brokers can help you reach your retirement goals. Please call us on (08) 9289 7777 if you have any enquiries about investing with super.

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