Building on our previous articles about SMSF and property, this piece highlights common mistakes made by others and how to avoid them. These Mistakes are categorized into the pre-planning phase, the borrowing process, and once the loan is in place, making it easier to follow and reference later. In my view, these mistakes are the primary sources of investor frustration and extra costs, often leading to very negative experiences when borrowing to buy property within an SMSF. It's best to steer clear of them!
Before the Purchase:
Mistake #1 – Assuming an SMSF Property Purchase is a Standard Process
The superannuation system is designed as a concessionally taxed system with the sole purpose of providing retirement income. Regulators are committed to maintaining this goal, so it's crucial to keep this in mind when dealing with any superannuation-related issues, especially with your self-managed super fund.
There are numerous compliance obligations to consider that wouldn't be relevant if you were buying property in your own name or through a family trust. Those who dive in expecting to correct mistakes later should be aware that the system allows little room for Mistake or mitigation.
Mistake #2 – Not Seeking Pre-Approval of a Loan and Understanding the Lender’s Requirements Before Incurring Costs
I recommend using a broker to determine exactly what the lender will require for a loan and to check if you qualify financially before incurring any costs. Expect closer scrutiny of the fund’s deed and financials, your own financial position, and the advice you’ve received compared to ordinary property loans, as the lender is offering a limited recourse product.
Mistake #3 – Using Outdated SMSF Trust Deeds
Limited recourse borrowing arrangements for superannuation funds are relatively new, introduced in September 2007 with major updates in July 2010 and 2013. Recent clarifications may be needed to implement your chosen strategy. Any trust deed set up before July 2007 likely lacks the relevant powers to borrow, grant a charge over an asset, or use a holding trust. Therefore, I always recommend upgrading the deed before starting the process.
As the lender’s solicitors will review your deed before authorizing the loan, any omissions will result in delays, costs to rectify the deed, and possibly additional fees to the lender’s solicitors to approve subsequent changes. This could cause you to miss your settlement date and breach your contract.
Mistake #4 – Lacking a Consistent Record of Contributions or the Ability to Forecast Future Contributions
Planning in advance for this strategy is essential to display a history of regular contributions to the fund to satisfy bank requirements. Banks will question the lack of contributions as a sign of financial hardship or lack of commitment to building liquidity in the fund. You also need to show the capacity to make future contributions. The lowering of the concessional contributions cap to $25,000 has already caused issues for some single-member funds.
During the Contract Process:
Mistake #5 – Not Assigning One Person to Manage and Control the Process
The process, as detailed in last week’s article, involves multiple parties: the lender, the vendor, your legal advisers, your tax advisor/accountant, possibly a legal document company, and a mortgage broker. Any delay in this chain can be a nightmare to resolve. Having someone knowledgeable about SMSF property investment to oversee the deal and act as the central point of contact for all involved parties can be incredibly beneficial. Without this, untangling issues can become a significant mess.
Mistake #6 – Purchasing Property Before Properly Setting Up the SMSF or Registering the Holding Trustee
There is no room for impulsive "buy now, think later" decisions when dealing with an SMSF. If the SMSF is not set up, then a trust does not exist. Signing a contract or placing a deposit for a property without having the holding Trustee Company established can lead to double stamp duty and capital gains tax issues. The use of “and/or nominee” is particularly risky outside of Victoria.
Mistake #7 – Incorrectly Setting Up the SMSF and Holding Trust
Using individual trustees for either the SMSF or the holding trustee can lead to delays or refusals in financing and potential exposure to litigation, putting personal assets at risk. For example, if a tradesperson is injured while working on the property and sues for negligence, an individual trustee will be directly exposed. Using a trading company as trustee for either position is also a mistake, as it can compromise the “bare” trust arrangement.
In some states, such as NSW, using an “and/or nominee” clause could result in ad valorem duty being charged when you nominate the holding trustee as the alternative purchaser, as this can be seen as a ‘sub-sale’. Currently, Victoria is the only state where ‘and/or nominee’ can be used, but you should verify the rules with a local solicitor or conveyancer.
In NSW, Tasmania, the ACT, South Australia, Queensland, and Victoria (subject to the above), the purchasing entity should be named as the holding trustee only. Avoid references to “as trustee for the bare trust” or “as trustee for the XXX SMSF”. Incorrect naming can result in adverse and possibly double stamp duty implications.
In WA, the word ‘for’ instead of “as trustee for” must be used between the holding trustee and SMSF trustee names. It should be “Holding Trustee Pty Ltd ACN for Super Fund Trustee Pty Ltd ACN”.
For NT property, the purchaser’s name on the contract must be very specific: “Holding Trustee Pty Ltd ACN as trustee for Name of Holding Trust as bare trustee for Fund Trustee Pty Ltd ACN as trustee for Name of Fund ABN”.
Mistake #8 – Not Properly Implementing Rules Concerning ‘Single Acquirable Assets’
The rules state that trusts should purchase a single asset on one title. The ATO ruling SMSFR 2012/1 provides clarity by explaining under what circumstances an asset could be viewed as a single asset, which mainly revolves around whether it cannot be dealt with separately (even if multiple titles are involved). The ATO provides 15 examples as a guide.
Mistake #9 – Using the Lender as Holding Trustee in a Related Party Loan (Where You Lend to Your Fund)
Any conflict, such as the holding trustee also being the lender to the fund, may weaken the “absolute entitlement” of the SMSF to the asset. This could have capital gains and land tax consequences for the fund. For example, if the loan comes from your family trust and the trustee of that family trust also acts as the trustee of the holding trust, it creates a conflict.
Mistake #10 – Signing Up the Holding Trustee as the Borrower Instead of the SMSF Trustee
It's crucial to remember that the holding trustee's role is solely to hold the title. The SMSF trustee is the beneficial owner and must be listed as the borrower on all documentation. If the holding trustee is mistakenly signed up as the borrower, full stamp duty will be payable on any transfer of title from the holding trustee to the SMSF trustee once the loan is paid off. Sometimes, the holding trustee may need to sign documents to make them effective. In such cases, it should be clearly noted that the trustee is acting on the instructions of the beneficial owner (i.e., the SMSF trustee).
Mistake #11 – Paying Holding Fees, Deposits, Settlement Payments, or Any Costs from Sources Other Than the SMSF
All payments related to the transaction must come from the SMSF bank account or the loan facility. To facilitate the property transfer upon loan completion, documentary evidence showing the payment trail must be submitted with the request. This is another reason to get the holding trust deed stamped early, as recommended, to identify and correct Mistakes before finalizing financials. This proactive approach is far better than trying to resolve issues years later.
After the Settlement:
Mistake #12 – Violating the “Safe Harbour,” “Arm’s Length,” and “Sole Purpose” Rules When Dealing with Related Parties
If you interact with the SMSF directly or through a company or trust entity controlled by you or a related party, you must treat these interactions as if dealing with a third party. Here are a few examples:
· Establishing a proper lease for business real property.
· Paying rent on time.
· Making loan repayments on time or charging penalty rates as per the loan agreement.
· Avoiding personal use of an SMSF residential property, even if you agree to pay rent.
· Not allowing your child or sibling to move into a residential property during tough times.
For more information, see the ATO guidance on related party SMSF loans (LRBAs).
Mistake #13 – Delaying the Stamping of the Holding Trust Deed
The holding trust deed must be stamped to ensure that the final transfer from the holding trustee to the SMSF trustee incurs only nominal stamp duty. Best practice, and in some states the rules dictate, is to have the final transfer stamped generally within 30-90 days after activation. It makes sense to gather all supporting documents and confirm the process before completing the fund's financials for the year.
Imagine if your spouse passed away or you lost some bank statements/documentation when trying to do it later, resulting in double stamp duty being applied by state regulators. It's better to be safe than sorry.
Mistake #14 – The Holding Trustee Performing Duties Beyond Holding Legal Title
The holding trustee's sole purpose is to hold legal title to the property while there is an outstanding loan. It may also grant security via a mortgage to the lender and enter into leases of the property on behalf of, and as instructed by, the SMSF trustee. A common mistake is for the holding trustee to have its own Australian Business Number (ABN), Tax File Number (TFN), or bank account, which should be avoided.
If the holding trustee performs any other active duties and does not act solely at the direction of the SMSF trustee, the holding trust may be considered a separate entity for GST reporting purposes. It would then need to prepare and lodge tax returns, and the look-through approach to the holding trust may not apply for income, land tax, and CGT purposes, meaning it would be outside the concessional superannuation environment.
Beware of any lender that requests additional duties for the holding trustee, and have your solicitor seek to remove these clauses.
Mistake #15 – Not Considering the Liquidity Needs of the SMSF During the Retirement Phase
If you plan to transition your fund into the pension phase while still holding the property, ensure the fund has enough liquidity to pay the minimum pensions, expected lump sums, and maintenance costs, such as accounting and advice fees. If unable to do so, you may need to return to the accumulation phase and pay tax on the rental income.
Mistake #16 – Not Considering the Liquidity Needs of the SMSF During Periods of Property Vacancy
Property occupancy is rarely continuous, so you need to ensure you have the liquidity to make loan repayments and cover property expenses during tenant vacancies. This is why we caution against setting up funds with small balances or using a high proportion of the fund balance for a single asset purchase.
Mistake #17 – Not Considering Insurance for the Property, SMSF Members’ Lives, or Contribution Capacity
It's essential to ensure the property is insured in the name of the SMSF trustee so that the loan can be paid off in the event of fire or destruction. Additionally, unless you have other funds available within the SMSF or can contribute enough to repay the loan upon a member's death, you should have life and disability insurance coverage at least equal to the loan amount for each member. Trustees are now legally required to regularly consider the insurance needs of the members. If you are negatively gearing and relying on your contributions to cover loan repayment shortfalls, you should also consider income protection insurance.
Mistake #18 – Misunderstanding the Rules for Using Borrowed Funds for Repairs and Maintenance Versus Improvements
While you can embrace your DIY renovator spirit, the property developer within you may need to be restrained when dealing with SMSF property under a limited recourse borrowing arrangement. According to SMSFR 2012/1, you can use borrowed funds for repairs and maintenance but can only make limited improvements with other SMSF funds. Your SMSF’s auditor and the ATO will closely monitor such expenses and their funding sources. For more details, refer to "SMSF Borrowing: What Can I Do With An Investment Property Within The Rules."
Mistake #19 – Creating a ‘Replacement Asset’ by Over-Improving
Remember, this is an investment within a heavily regulated structure aimed at providing for your retirement, not a business venture. Be cautious of any form of ‘development.’ If your improvements are so extensive that the resulting asset is substantially different from the original, you may have created a ‘replacement asset’ in the eyes of the ATO. Examples include:
· Subdividing a single plot of land into smaller plots with individual titles.
· Building a house on a vacant plot of land.
· Demolishing an existing house and replacing it with multiple strata title units.
· Re-zoning land with an existing house and transforming it into commercial premises.
If the ATO deems the asset's character has changed significantly, it may consider it a replacement asset, making the SMSF non-compliant.
Mistake #20 – Not Registering for GST in the Name of the SMSF Trustee Only
For commercial properties with a GST turnover exceeding $75,000, you only need to register the SMSF for GST, not the holding trust. This means that if the property is transferred to the SMSF trustee, it does not constitute a taxable supply and does not incur a GST liability.
Conclusion:
This list covers many common mistakes SMSF trustees can make when managing a loan to purchase property within their super. It's crucial to plan the property purchase carefully, avoid acting hastily, and seek advice from someone with a clear understanding of the laws. Experience in handling the transaction from start to finish is essential to avoid repeating others' mistakes.
As always, please contact me if you want to explore your options. You can make an appointment by clicking [here].
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