Australia’s love affair with property means many people are interested in investing their super fund money in property. Unlike normal public or industry super funds, a Self-Managed Super Fund (SMSF) in Australia offers members more control over their retirement savings by allowing a broader range of investments which includes allowing trustees to invest in residential and commercial properties. SMSFs can also borrow money to fund the purchase if needed.
They can also offer significant tax advantages for high-income earners with SMSF income taxed at a maximum rate of 15%. However, extreme caution is a must before proceeding as the consequences of not doing it correctly are significant.
Understanding Compliance and Responsibilities
The Australian Tax Office (ATO) watches SMSFs with direct property investments very closely so compliance with all requirements is critical. This includes accurate record-keeping, annual fund reporting on time, and trust deed adherence.
Trustees must focus on investments that serve the sole purpose of providing retirement benefits and that are appropriate and consistent with the fund’s investment strategy. Therefore, there can be absolutely no private use of a residential property owned by an SMSF by the members or their associates regardless of whether rent would have been paid or not. It is also important to note that an SMSF cannot buy a property direct from a fund member or related party.
Tax Considerations and Efficiency
SMSF property investment can offer significant tax efficiencies. When a super fund is in Accumulation Phase the SMSF’s net rental income will be taxed at a maximum rate of 15% and the capital gains tax rate on assets held for over 12 months are only subject to 10% tax. When a fund moves into Pension Phase the rental income and capital gains become tax free!
However, it is important to note that it is not necessarily tax effective to negatively gear a rental property in a Super Fund because the fund only saves 15% tax on the loss it makes each year. If you were a high income earner and owned the property personally you’d be able to save up to 47% tax on the loss.
The Importance of Asset Diversification and Cash Liquidity
SMSF’s must maintain asset diversification. Investing heavily in just one kind of asset ( eg a single property or only in property) can pose risks, as it concentrates the fund’s assets in one investment type. Diversification across different asset classes helps mitigate these risks.
This is why you may find that if finance is required, the bank will enforce this requirement for diversification by requiring that only 80% of the fund’s money is used as the deposit on the property, with 10% required to be retained in cash and 10% invested in other investments.
Correspondingly, cash liquidity is vital, especially for Self-Managed Super Fund’s in the pension phase or those with property loans. The fund needs sufficient cash flow to pay for expenses, loan repayments and pension payments. Therefore could be challenging during periods of vacancy, if significant repairs or renovations are required, or if the member retires and there are no more employee contributions.
Borrowing Considerations for SMSF Property Investment
While SMSFs can borrow money for property investments, it’s essential to consider the current challenges:
Bank Reluctance and High Costs: Banks often hesitate to lend to SMSFs due to administrative complexities, leading to much higher application fees and interest rates.
- High-Interest Rates. Committing a Self-Managed Super Fund to debt can be risky with rising interest rates.
- Cash flow. Committing an SMSF to loan repayments can be risky especially if you are approaching retirement.
- Tax Deduction Limitations. The maximum tax deduction for interest in an SMSF is 15%, or 0% during the pension phase. This is less tax-effective compared to personal ownership of negatively geared properties.
Summary
While Self-Managed Super Fund property investment can be beneficial, it requires careful planning and consideration of regulations, diversification, liquidity, and potential borrowing challenges. Seeking professional advice is crucial for making informed decisions. The team at Everalls Wealth are experts to advise you in this regard. Our team works closely with our accounting partners at DFK Everalls. We also take a holistic view of your financial situation, paying close attention to your financial goals and future plans.
