According to the Australian Tax Office, real estate held within SMSFs is a very popular asset class. The most recent data shows of the $880 billion-odd held within all funds, there was $87.8 billion invested in non-residential i.e. commercial property, and nearly $47 billion held in residential property.
There was also nearly $62 billion held in limited recourse borrowing arrangements (LRBAs) otherwise known as SMSF loans. All up, that totals $196.42 billion, or nearly a quarter of the value of all assets held.
That said, if you’ve never bought a property through an SMSF before, it can be a little confusing as to how you do it - so where do you start?
Steps to buying property through an SMSF
SMSFs are typically subject to an annual audit to ensure they are compliant. So, it’s important to get it right. If you’re unsure where to begin or how to complete any of these steps it’s recommended you talk to a specialist SMSF adviser.
Step 1: Update trust deed and investment strategy
Before embarking on your investment journey you’ll need to update your trust deed and investment strategy documents in case they don’t yet allow for property investment. You will need to explain how the investment will benefit members through delivering returns and rent to the fund.
Step 2: Assess your cash holdings or apply for an SMSF loan
If you and your members have enough cash holdings in your SMSF bank account to buy a property outright, then more power to you. However, if you don’t, you will likely need to apply for an SMSF loan, otherwise known as an LRBA.
LRBAs carry with them an additional set of rules and considerations. Your lender will work with you through this process and can grant you pre-approval so you can shop for a property. Be aware though that due to the complex nature of SMSF lending, lenders typically take longer to formally approve your loan, which could push your settlement time out.
Before formally applying for a lender you will likely need to skip ahead to steps 3 and 4 and establish a bare trust with a property in mind.
Step 3: Find a property
After you’ve established that you have enough cash or have been pre-approved for a loan now comes the fun part. As a trustee you will need to look beyond whether the property is appealing to you - you will also need to consider what might deliver steady rental returns and capital gains to benefit SMSF members.
Step 4: Establish custodian or bare trust if borrowing money
An SMSF cannot legally borrow money by itself; for that you will need what’s called a bare trust, which holds property on the fund’s behalf without any beneficial interest. This is to satisfy the ‘at arm’s length' requirement set by LRBA laws.
The SMSF trustee must set up the bare trust and create a Declaration of Trust establishing the terms of purchase. This may be able to be organised through your accountant or financial adviser.
If you need an SMSF loan, before establishing a bare trust you will need your property’s details. This seems like it’s putting the cart before the horse but you will need to supply property details to your accountant so a bare trust can be established in the first place.
Step 5: Settle on the loan and property
Once you have found a property and established a bare trust it’s time to formally apply for a loan. This process may take longer than a normal home loan because of the documentation and legalese required. In a hot property market where 21 or 30-day settlements are common, this means you need to act quickly if you want to secure the property you’ve had your eye on.
Step 6: Manage the property and source tenants
Trustees will need to find a property manager or source tenants themselves, pay expenses, and collect rent. Finding tenants must be done at market rates and on an arm’s length basis.
All income and expenses must be reported to the Australian Tax Office. Rent must be paid into a bank account held within the SMSF.
Self-managed super fund (SMSF) home loans
|FEATUREDINCLUDES NOV RBA RATE INCREASE|| |
loans.com.au – SMSF 70
loans.com.au – SMSF 70
Firstmac – SMSF 70 (Refinance Special)
Liberty Financial – Liberty Residential SMSF (LVR < 80%)
La Trobe Financial – SMSF Residential
|INCLUDES NOV RBA RATE INCREASE|
loans.com.au – SMSF 80
Firstmac – SMSF 80 (Refinance Special)
Rules when buying a property through an SMSF
Benefit members/sole purpose test
SMSFs must abide by what’s called the sole purpose test, and this must be outlined in the trust deed. The sole purpose is basically to benefit SMSF members and trustees in retirement.
So, if you’re buying a property, it must be with the intention of it gaining value and collecting rent over time so when members retire and drawdown on the fund, they will be better off.
At arm’s length
SMSF property investments must be done ‘at arm’s length'. For a residential property, you can’t rent to another fund member or family member, and the rent must be at a market rate. You can’t also just let the property sit - there must be a genuine attempt at getting tenants.
For commercial property it’s a little different - you can rent to a related party, including yourself, but it must be done at market rates. A popular avenue for small business owners is to buy a commercial property for their SMSF, have their own business rent it, and then pay rent back into the fund.
An investment strategy is basically an annually-updated document that outlines your investments in the fund, and a justification for doing so i.e. how it will benefit members.
If you purchase a property in an SMSF you will likely have to update your investment strategy to reflect this.
Can’t put existing investment property in SMSF
You or other members/trustees can’t put a property you already own as an investment into your SMSF, no matter if it’s sold/purchased at a market value or if you’ve contributed to it within your SMSF contribution limits.
Where you run into more restrictions is if you need an LRBA or SMSF loan to fund your property purchase. If purchasing through an LRBA, there are a couple restrictions to keep in mind:
You usually need a minimum amount balance and minimum contribution amount per year (dependent on lender)
You usually need at least 20% deposit or more
You usually can’t borrow to build on vacant land as this is considered an improvement/renovation
For commercial property there might be additional restrictions as to the type of property you can buy e.g. farms, or exotic use cases such as racetracks might be ruled out.
Benefits of buying a property through an SMSF
Can rent it out to yourself (commercial property): If you invest in commercial property and if you’re a small business owner, you can ‘rent’ out your property to your business; you then pay rent into the SMSF. You can also rent it out to other related parties provided it’s at market rates.
Control over your investments: Unlike a retail super fund you choose exactly where to direct your investments.
Leverage if you have a loan: If you have an SMSF loan, you are leveraging yourself. You might not have the cash to pay for a property, but you can leverage and magnify gains with say a 20% deposit. On the flipside you also magnify losses this way.
Tax benefits: Income of SMSFs are generally taxed at a concessional rate of 15%, which may be lower than if a property generating income were held outside of the fund.
Can borrow for maintenance and repairs: With an LRBA you can borrow extra for maintenance and repairs. This might include say a leaky roof. However renovations are out, because they are for adding value, not necessary maintenance.
Considerations when buying a property through an SMSF
Concentrated/undiversified investment: You are buying one property, in one location, which concentrates your investment and could enhance risk. You will need to account for this in your investment strategy document.
Risk of downturn: Australians and governments love the idea of property only ever going up in value, but the truth is, the market ebbs and flows like any other. And Australia isn’t just one market - your individual house could lose value while others in the street somehow gain value, for example.
Interest rates higher on loans: Interest rates on SMSF loans are generally higher than other types of home loans. This is because of the ‘limited recourse’ factor mentioned above.
Can’t borrow for renovations or improvements: LRBA rules stipulate that you can’t borrow funds for making improvements to the property, only necessary maintenance.
Selling restrictions: Just as you would when buying property, you also need to do all the checks and balances if you want to sell the property. This includes setting up the trust deed and investment strategy to allow for this.
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