So, you’ve heard you can buy an investment property with your superannuation? Let's break down what this means, the pros and cons, and where you can find more detailed information on commonly used strategies.
People have been using their super to buy property in their SMSFs for decades, but it really took off when SMSFs were allowed to borrow to buy assets in 2007, with more clarity on borrowing to buy residential property coming in 2010.
Investing in property within super isn’t as straightforward as investing outside the super environment, so you need to do your homework. Buying property through super can be a fantastic way to invest for retirement, but it’s most suitable for those who are 15 to 25 years away from retiring. These folks likely have 20 years or more of contributions and sufficient balances for a deposit, plus they are more likely to hold the property until after retirement to realize the best tax savings.
For more detailed guidance on specific strategies and the implementation process, visit my Property in an SMSF page.
Property Investment in an SMSF
Combining your super accounts into an SMSF can open the door to buying both residential and commercial property, with or without a mortgage from a lender. However, it’s crucial that all investments serve the best interests of fund members and meet the Sole Purpose Test of super legislation.
Ensure any property investment has an income stream and realistic prospects for capital growth. An SMSF investment strategy must consider the personal circumstances of all fund members, including their age and risk tolerance. The strategy should cover:
Diversification: Investing in a range of assets and asset classes
Liquidity: How easily the fund’s assets can be converted to cash to meet expenses
Ability to Pay Benefits: When members retire and other costs the fund incurs
Members’ Needs and Circumstances: Such as age and retirement needs
Insurance: Steps to insure members and protect their retirement savings
What to Include in Your Investment Strategy
When purchasing any investment asset through an SMSF, the Australian Taxation Office (ATO) provides the following guidance:
Arm’s Length Basis: Investments must be purchased and maintained on a strict commercial basis.
Sole Purpose Test: The investment must provide retirement benefits to fund members.
For property, this means the purchase cost, sale price, and rental income must reflect a true market rate of return. You cannot buy the property from or sell it to someone associated with any of the fund’s members (a “related party” transaction). Additionally, neither you nor anyone associated with you can receive any personal benefit from holding the asset.
Pros and Cons of Holding Property in Superannuation
Pros:
Combined Investing: Your personal savings outside superannuation, or even your individual account balances within superannuation, may not be enough to meet the deposit requirements of direct property. Combining your account balances with other family members may provide the purchasing power needed for a large asset.
Tax Effectiveness: Super receives concessional tax treatment on assets used to save for retirement. Earnings within your super fund are taxed at only 15%, with a 33% discount for assets held more than 12 months (i.e., 10% CGT) – likely less than your marginal tax rate. If you hold the property until retirement, the earnings within the pension phase are tax-free, including rent or sale proceeds (subject to the $1.9 million pension transfer limit per member from 1 July 2024).
Pre-Tax Repayments: If you can afford to save and have room within your concessional contribution limits, you can salary sacrifice additional income to super to pay off the loan quicker from pre-tax dollars, paying 15% on salary sacrifice rather than your marginal tax rate on the income.
Supporting Business Growth: While you can’t purchase a residential property from yourself or a related party, you can buy commercial or industrial property (known as Business Real Property) to lease back to your own business, provided you pay a current market rate of rent, freeing up funds to grow the business.
Control and Value Addition: Many SMSF investors appreciate having control over their investments and the ability to “value add” to their property investments via renovation or development. There’s no substitute for that feeling when you know exactly where your money is invested.
Cons:
Illiquid Asset: Diversification is harder to achieve if your SMSF owns just one or two large assets. This lack of diversification may not be in the best interests of SMSF members, especially across generations. Plan your “what if” strategies, and look at insurance, cash buffers, and the funding of future pensions upfront. The old adage “You can’t sell off a bathroom when you need cash” comes to mind.
Higher Set-Up Costs: There are substantial set-up costs, and sometimes higher fees are involved in getting a loan through your SMSF. Because of the costs, buying property through an SMSF is generally only suitable for funds with $200,000 or more.
Limited Negative Gearing Benefits: If you borrow to buy property through your super and are negatively geared, the tax offset only applies to other income earned within the fund, taxed at only 15% – not at your marginal tax rate on regular income.
No Personal Benefit: Investments within an SMSF must be purchased via an ‘arm’s length’ transaction and maintained on a strict commercial basis. You cannot purchase from, lease to, or rent to a related party. The ATO advises that common breaches of the sole purpose test often involve assets providing a pre-retirement benefit to a member or associate. Examples include using a SMSF property as a personal holiday house or renting it to a family member.
Future Cash Flow Certainty: You will likely need a higher deposit than if borrowing directly. While you can borrow to buy property within an SMSF, you cannot borrow to build or improve the property. Ensure that your contributions, plus the rental income, will be enough to cover any costs you need to meet from cash. Consider having decent income protection insurance as well as life and TPD insurance for the term of the loan. A cash buffer is essential.
Liquidity at Retirement: When your super transfers to the pension phase, ensure you have built up sufficient cash to fund required pension payments without risking a fire sale of the property. This ranges from 4% of the pension member’s balance before 65, to 5% from 65-74, and upwards from there.
Reduced Personal Borrowing Capacity: Banks typically ask for personal guarantees, which can restrict your personal borrowing power.
There are many tips and traps to be aware of when it comes to investing within an SMSF. I’ve covered over loads of articles on the subject, all available free on my blog at www.wesmsf.com.au.
Do some reading and your own research, and ensure you get professional advice on your circumstances and assistance from our team or your advisors before setting up your fund or starting the strategy.
Thank you for reading! We hope you found this guide helpful. Your feedback is always appreciated, so feel free to leave a comment. Don’t forget to share the love by re-blogging, retweeting, or liking us on Facebook to help spread the word. If you have any questions or want to explore your own options, please don’t hesitate to contact us. We’re here to help!
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