Superannuation (‘Super’) is the mandated Australian way of providing for retirement. Employers are required to make contributions into approved super funds for the benefit of their employees. Employees can choose whether they want the contributions paid into an Ordinary (APRA Regulated) Superannuation Fund, or a Self-Managed Super Fund (SMSF). To help you develop a better understanding of how SMSF Property Investment works, we’ve put together this Beginners Guide to SMSF Property Investment.
What are SMSFs?
While ordinary super funds have tens of thousands of members and investments are overseen by an appointed fund manager, SMSFs, on the other hand, can have a maximum of four members, and they are responsible for the fund activities themselves, including compliance to all laws, rules, and regulations.
All members of a SMSF must be trustees of the fund. SMSFs are recognized as a legal tax structure and they are regulated by the Australian Tax Office (ATO).
Superannuation owners often choose the SMSF format for investing in ‘alternative’ assets whereas the managers of ordinary super funds lean more towards ‘mainstream’ asset classes.
Examples of alternative asset classes include –but are not limited to- collectibles and cryptocurrencies. Another favourite with SMSFs is to invest in the real estate market – more information below.
How a SMSF can invest in Property
Where the trustees of a SMSF believe that the real estate market is a suitable investment class for the specific objective(s) of the fund, its investment strategy, and also its risk profile, then they may elect to purchase a property.
However, strict rules apply. And in the event of non-compliance, the ATO may impose significant penalties, prosecution, and even disqualify the trustees of the SMSF.
The following rules for SMSF property purchases are currently in place:
The property must satisfy the ‘sole purpose test’, which means that the purchase thereof must be solely to provide retirement benefits to the SMSF members
The SMSF may generally not purchase a property owned by a fund member or related party. An exception is where the SMSF purchases a business premises owned by a fund member and where the business then pays rent to the SMSF at a market related rental rate
The property must not be rented by a member of the SMSF or any related party of the member
A fund member or related party must not live in the property. The only exception is where the property is a business property used for primary production –e.g. a farm- which includes a dwelling. And then the dwelling may not occupy more than two hectares of the land. Also, the main use of the remainder of the property must be exclusively for business purposes.
Generally, SMSFs are only allowed to purchase property with its own funds. Only one exception applies – see below for more information.
Can a SMSF Borrow Money to Invest in Property?
An SMSF may only enter into a property gearing agreement under very strict conditions, i.e. a ‘limited recourse borrowing arrangement’. And only a single asset may be purchased, e.g. one residential property or one business property.
Before entering a limited recourse borrowing arrangement the fund’s trustees must first weigh the risks associated with geared SMSF property purchases:
Costs – SMSF property loans may be more costly than other property loans
Cash flow – the fund needs to have sufficient cash available to cover loan repayments as and when they are due
Cancellation – poor contract setup and/or paperwork may make it impossible to unwind or cancel the arrangement which could result in substantial losses to the SMSF
No alterations to the property which change its character are allowed until the loan is fully repaid
SMSF property tax losses may not be offset against other income outside of the fund.
Investing in property may be a great way for a SMSF to reach its objective of providing for the retirement of its members.
However, it is very important that all the pros, cons, rules, regulations, and possible pitfalls are considered before such an investment is made.
It is highly recommended that a licensed SMSF adviser is consulted before such an important decision.