Using Your Self-Managed Super Funds [SMSF] for Property Investment
Investment in property is a lucrative option for Australians and investing in residential and commercial property can generate a side income for many.
Thinking of buying a house as an investment? Coming up with a down payment and covering initial costs for your property can be a significant financial expense and you may struggle with arranging the required funds.
One great way to pay for your investment property is through your super funds. Even though it is an option many people forget when buying property, using super funds can be a great idea. Before you go on to use your super, make sure to go through this simple guide.
Can You Use Super To Buy Property?
While you can use a super fund to buy property, you can’t use all types of super funds to purchase a property.
There are rules for buying a property with super you intend to live in versus an investment property you plan to rent out. It may not be as easy as withdrawing the funds you need from your super and using that money to buy your choice of property.
Many different kinds of Supers exist but the two main types are regulated superannuation funds and self-managed super funds. Superannuation funds consist of retail, corporate, public sector, and industry funds, while an SMSF is one you can choose to invest on your own instead of having a fund or investment manager choose your investments. With SMSF, it’s expected that you are an expert fund manager, with expertise in choosing between a mix of investments that aren’t necessarily restricted to an industry sector or type of company.
If you want to purchase a property, you must withdraw funds from an SMSF, whereas you will not be able to utilise your for-profit or profit-to-member investments like those from your regulated superannuation funds.
What Kind of Property Can You Buy With Super?
The types of property you can buy with a super fund are limited. With a self-managed super fund, you can buy commercial investment properties or a residential property you don’t intend to live in.
You can’t use money from your SMSF as a downpayment on a home loan for a property you want to use as your residence.
In addition, a fund member or a related party of the fund members cannot live within the property. Known as the arm’s-length rule, the definition of a related party can include individuals such as relatives, spouse, children, and extends to your business partners or trust members as well.
That said, Australians wishing to buy a home to live in and are first home buyers can consider the First Home Super Saver Scheme. In Australia, this scheme lets you save for a home loan deposit or downpayment through voluntary contributions to a superannuation account. There aren’t any minimum or maximum value restrictions on the home’s purchase price but the residential property must be within Australia’s borders.
Using SMSF To Buy Property
When you buy property with SMSF, you’ll need to follow various rules and considerations set in place. Every homeowner must know these rules before deciding to proceed with a property investment. Otherwise, there can be penalties and legal consequences for incorrectly using a super.
1 Setting up an SMSF doesn’t require a minimum balance. However, you need enough funds and cash flows to accommodate property payments and account fees. For example, the ATO mentions some fund charges which can include the following:
- Investment related expenses
- Operating costs
- Management and administrative fees
- Audit fees
- Australian Securities and Investments Commission annual fees
With an SMSF, you need to budget for these expenses and ensure you’re contributing or earning enough from your investments to fund them.
2. An SMSF can have one to four fund members who are responsible for making decisions about the fund including investment decisions regarding how to use available funds. Fund members may decide to invest in shares depending on everyone’s financial preference, but investing in property is often more desirable because it offers higher returns and stability.
3. An SMSF also requires trustees who can be from amongst fund members, be either an individual, or a corporate trustee who ensures members follow all compliance requirements.
4. You can’t use all of your super fund balance to buy an investment property. Some funds can’t be put into a property investment because you must leave them behind as a buffer. A liquidity buffer is a requirement with some forms of cash and share investments and must represent 10% of the property investment value.
5. The bank or lender usually lends a lower amount to the fund than that lended to an individual buyer [around 60-70% of the total property value] and the interest rate charged may also be higher than that for an individual buyer.
6. Another stipulation is that related parties and fund members cannot take out loans against or sell assets to an SMSF. This rule applies as long as you’re using funds to buy an investment property. Related parties include:
- A trust that a fund member or one of their associates controls
- A company that a fund member or one of their associates controls or influences
- Relatives of any fund member
- Business partners of every fund member
- Spouses and children of fund members’ business partners
- Employers who make contributions to fund members’ superannuation funds
Since this list of related parties can become extensive, full and prompt disclosure is critical for compliance.
Using Super for Property Loan
The SMSF can also be used in making a deposit to get a loan which is then used to buy a property. While you can’t use super funds to cover the property’s price, you can cover the remaining price with a home loan. As you may already be aware, your deposit or down payment represents a certain percentage of the total purchase price.
Using SMSF funds for your deposit gives you the advantage of leverage and gearing. However, you must get the approval of your SMSF trustee under a Limited Recourse Borrowing Arrangement. Also known as an LRBA, this agreement involves the trustee taking out a loan from a third party lender, such as a bank.
The trustee then uses the loan money to buy property under a separate trust. It’s important to seek professional advice from a skilled financial adviser before you use SMSF funds for a property loan deposit as the process can be expensive in the long run.
Residential vs. Commercial Property Investment
There are fewer complications when you buy property for investments with super funds if you intend to purchase commercial property instead of a residential one.
Commercial property is real estate that owners, and organisations typically rent out as office or storefront space to businesses. It’s an investment for property owners since they earn rental income to pay back mortgages and keep as savings.
While you can use SMSF funds for a residential property, you can’t live in it. Neither can any related parties. Someone else must rent and live in that property.
In addition, you can’t use SMSF funds for an existing residential property you already live in. This scenario might come up if you need to refinance a current loan. The rules clearly state that the fund cannot buy assets from its trustees, members, or related parties.
That said, there are investment rules for commercial properties you should know about:
- You can sell or lease existing commercial properties to fund members and related parties.
- Compared to traditional lending, the typical loan-to-value ratio is also lower when you apply for a commercial property loan.
- Small business owners who buy commercial properties and rent them out must pay the rent directly to the SMSF. Rent should be based on the market rate and paid in full each month.
- The investment must also pass the sole purpose test, which represents the SMSFs goals and purpose. This purpose is usually to provide retirement benefits through the property’s yield and the expected capital growth in the property’s value.
Tax Implications of SMSF Property Investment
A property investment using SMSF funds has several tax implications which can include:
- A 15% tax on SMSF income including rental income and capital gains.
- One-third discount on capital gains from increase in property value if you hold the property for more than a year [12 months] before selling. Your capital gains tax goes down to 10% [1/3rd of 15%].
- Interest payments are tax deductible if you purchase investment property with a loan.
- Once trustees start receiving retirement benefits or pension payments, rental income and capital gains become tax free.
- Transferring property may have stamp duty, capital gains tax, or other tax implications.
Get Expert Advice
SMSF funds can help you purchase property for investment and benefit you at retirement. However, to enter into the property market SMSF members should devise a sound investment strategy and evaluate their financial situation before diving into this form of investment.
This is why it’s best to reach out to a financial expert for additional clarity. They can help you better anticipate the expected costs and benefits of using an SMSF.