Self-Managed Super Funds (SMSF) And Purchasing Property

Self-Managed Super Funds (SMSF) offer a variety of benefits, including more control over your retirement savings, the ability to invest in a wider range of assets and potential tax savings.

However, before taking advantage of these benefits, you need to know the rules governing SMSFs. This blog post will discuss some of the key things you need to know about SMSFs and purchasing property.

A self-managed super fund, often known as an SMSF, is something to consider if you have plans to invest in real estate in the near future.

Having control over your finances and finding it easier to save up for a property purchase are both benefits that can come from using a self-managed super fund (SMSF). This article on the blogger's website will explain how to begin the process of establishing a self-managed super fund (SMSF) and will discuss the advantages of using such a fund to make real estate purchases.

Self-managed super funds (SMSF) can be a great way to save for retirement, and they can also be used to purchase a property.

However, before you make the decision to use an SMSF to acquire property, there are a few facts regarding SMSFs that you need to be aware of. In this piece, we'll look at some of the most important aspects you need to understand about SMSFs and owning property so that you can make an informed decision. In addition to this, we will go through some of the benefits and drawbacks of purchasing real estate with an SMSF.

As a growing number of Australians desire to exert a greater level of influence over their own financial situation, the use of self-managed super funds (SMSFs) has seen a surge in popularity in recent years. An SMSF is a self-managed superannuation fund that can be utilised not only for retirement savings but also for the acquisition of real estate.

However, before establishing a self-managed super fund (SMSF), there are a few essential items to think about, particularly in the context of purchasing property. In this article, we will provide an overview of the steps involved in buying property using an SMSF, as well as a discussion of some of the most important advantages and disadvantages associated with making such a purchase.

Are you curious about the self-managed super funds (SMSF) and the ways in which they can be utilised to finance the acquisition of a home or other real estate? If that's the case, you've arrived at the correct destination! This article will provide an introduction to SMSFs as well as an explanation of how they function.

We'll also discuss the benefits of using an SMSF to purchase property and explore some of the key things you need to know before getting started. So, if you're thinking about buying property through an SMSF, keep reading!

Let's get started!

What exactly is meant by the term "self-managed super fund"?

A self-managed super fund, also known as an SMSF, is a type of pension trust system that is intended to provide its members with benefits after those members reach retirement age. The members of an SMSF are considered to be trustees, which sets it apart from other types of super funds.

They could have anywhere from one to four people taking part. They are favoured over other types of retirement plans because they provide the trustees a large amount of discretion, allowing them to tailor the funds to meet the specific requirements of each participant in the plan.

Self-managed super funds, often known as SMSFs, are a type of investment vehicle that can be found in the Australian market.

According to the statistics, there are around 600,000 SMSFs in Australia, and there are approximately 1.1 million members. They are responsible for around 25 percent of Australia's superannuation system's total assets, which amount to 2.7 trillion dollars.

The use of a self-managed super fund (SMSF) to make real estate purchases has recently seen a surge in popularity; nevertheless, it is essential to seek the appropriate financial and legal counsel before doing so.

There are rules to follow if you want to invest in residential or commercial real estate, but it is possible.

Investing in commercial real estate as opposed to residential real estate comes with a number of distinct benefits.

When it comes to residential property, the first and most important rule is that neither you nor any other trustee of the SMSF are allowed to rent it out or live in it yourself.

What Are Self-Managed Super Funds Used For?

The "sole purpose test" is something that a lot of people forget about when it comes to SMSFs because they forget that they provide retirement benefits for the members.

The following is a statement made by the Australian Taxation Office (ATO):

If you want your SMSF to be eligible for the tax discounts that are often only available to super funds, it needs to pass the sole purpose test. This indicates that your fund must be kept in existence only for the purpose of delivering retirement benefits to your members or their dependents in the event that a member passes away before reaching retirement age.

Whether you're a seasoned investor or a first-time buyer, collaborating with a reputable property advisor can be a valuable step toward making well-informed and profitable real estate decisions

Infractions of the sole purpose test are to be taken extremely seriously. In addition, the fund will no longer qualify for the preferential tax treatment.

If you or anybody else, either directly or indirectly, derives a financial gain while making investment decisions and arrangements, then there is a good chance that your fund will fail to meet the sole purpose test (other than increasing the return to your fund).

When you invest in collectibles like art or wine, you need to make sure that members of the SMSF don't have access to the assets of the SMSF and don't have the ability to use such assets.

If your fund offers a pre-retirement advantage to someone, such as the use of fund assets for personal use, then it fails the "sole purpose" requirement and cannot be considered a retirement fund.

How Do SMSFs Operate?

SMSFs are established with the specific intention of providing financial compensations to members upon retirement or to their beneficiaries in the event that members pass away.

Because each of them has their own Tax File Number (TFN), Australian Business Number (ABN), and transactional bank account, they are able to receive rollovers, make contributions, and invest money. They are also able to provide pensions and lump sum payments.

The trustees of the SMSF are responsible for managing all of the fund's transactions, which are all carried out in the fund's name.

Does Your Self Managed Super Fund Allow You To Borrow Money To Purchase Investments?

You absolutely can. Because of this, we are having a lot of fun here. However, the process is more complicated than a typical bank loan. For instance, you are required to make a significant deposit of approximately forty percent. A helpful page on borrowing can be found here on the ATO website. You also have the option of establishing a connection with an excellent financial broker.

One of the primary benefits of investing in real estate through your own self-managed super fund is the ability to take on additional debt.

Outside of the actual structure of the superfund itself, you will need a separate property trust and trustee in order to keep the property for the SMSF. This is done so as to limit the "lenders' recourse." The bank account of the retirement fund will be used for all of the property's financial transactions, including both revenue and expenses.

The retirement fund is responsible for making all necessary loan repayments. In the event that it is not successful, the lender has a way out in the form of the property that is held in a separate trust, but they are unable to access any of the super fund's other assets.

When compared to the conditions for a regular mortgage loan, those for a super fund are typically significantly more stringent. Because of the higher interest rates associated with these loans, it is vital to give thorough consideration to all of your other options before deciding to buy property in this manner.

If buying a home is your major motivation for establishing a self-managed super fund (SMSF), you should talk to a mortgage broker or a bank before you form the super fund to assess whether or not you have sufficient funds to qualify for a loan before you go ahead and construct the fund.

Your self-managed super fund (SMSF) must be used to make loan repayments. This indicates that your SMSF must always have sufficient cash available in order to be able to make loan repayments. The Self-Managed Superannuation Fund (SMSF) may be able to repay loans using money from rental revenue or contributions to retirement schemes made by its members.

Commercial Property

The proprietors of many firms make the investment in buying a commercial property so that the company can continue to function.

Although this is a lawful choice, you should keep in mind that the rent you collect must be at a rate that is consistent with that of the commercial market, and the lease terms must be consistent with what is considered acceptable and usual in the business world.

As a result, you need to be certain that the purpose is not to comply with the sole purpose test, but rather to ensure that the premises are provided at an affordable fee.

When investing in commercial real estate with your SMSF, it is essential to take into account the expected rate of return as well as the growth of the property.

Residential Property

You are not allowed to buy a home for yourself or another trustee with the intention of renting it out or living there. This is the single most crucial thing to keep in mind.

Additionally, you are not permitted to have family or friends rent or reside in the home at any time.

Don't even bother thinking about buying a vacation home or a house for your kids or any of those other things.

It is possible for an SMSF to purchase land for development, but there are several regulations to follow. For instance, you are not permitted to run a business in this state.

Loans and Borrowing

Your SMSF may submit an application for an SMSF loan in order to purchase property; however, there are stringent standards for compliance.

You are unable to buy multiple titles for the asset at this time.

It is of the utmost importance to be aware of the fact that any type of borrowing from the SMSF for the purpose of purchasing property can only be done so under a "limited recourse agreement."

This simply indicates that the lender's only option for seeking redress is against the property at issue.

Taxation problems

As long as all of the necessary compliance requirements are met, the net income that is earned by an SMSF will typically be liable to taxation at a concessional rate of 15%.

Gains on assets that have been held for more than a year will be eligible for a third deduction, bringing the effective tax rate down to 10% from 15%.

The Five Self-Managed Superannuation Funds Property Investment Rules That You Should Be Aware Of

1. Compliance Rules for Self-Managed Super Funds

Even while SMSF trustees have the authority to manage the decisions that are made about investment strategies, those decisions still need to be in conformity with all of the legal requirements.

The Australian Taxation Office, rather than the Australian Prudential Regulation Authority, is the body responsible for overseeing self-managed super funds; this sets them apart from typical superannuation funds (APRA).

The ability to demonstrate compliance with the sole purpose test is the single most crucial factor to take into account when developing an SMSF investment strategy. To pass the single purpose test, the SMSF must have been established for the exclusive purpose of delivering retirement benefits.

In addition to passing the sole purpose test, the trust deed and the trustees' responsibilities require that they:

• design a plan for their investments, and then make decisions on those investments in accordance with that strategy.
• purchase the right level of protection for each member of the SMSF to protect them against the danger of their investments
• only allow contributions from members to be made to the SMSF
• keep an eye on the overall SMSF balance as well as the transfer balance cap
• a registered auditor should be appointed to carry out the annual audit
• maintain the appropriate administrative documents for the purposes of record-keeping,
• before any member can withdraw funds from their SMSF, it is imperative that you check to see that they have satisfied the criteria of release
• submit an annual tax return to the ATO on behalf of the SMSF.

In the event that members do not comply with the sole purpose test as well as any other legal requirements, the ATO is authorised to impose a number of different penalties.

2. Residential Property Purchases from Related Parties are Prohibited

In addition to adhering to the regulations governing SMSF compliance, the ATO recommends stringent guidelines that dictate the kind of properties you can buy and from whom you can buy them.

In order for the investment property to be in accordance with these stringent standards, it must:

• not be bought from any fund members or family members of members;
• not serve as a place of living for members of the fund or parties affiliated to the fund; and
• not be a residence that is rented out to members of the fund or parties affiliated to the fund.

Example

Chloe and Mitch want to make advantage of the self-managed superannuation fund (SMSF) that they just established in order to buy a residential investment property.

Amy, Chloe's sister, is in the process of selling the apartment she has in Brisbane right now. Because of its highly desirable location and spacious interior, it would be an excellent choice for a real estate investment.

As a result, Chloe and Mitch investigate the possibility of purchasing the property from Amy.

However, after consulting with their financial advisor, they were informed that they are not permitted to buy property from Amy because purchasing a relative's residential property violates SMSF compliance rules. This information was provided to them after they learned that they were unable to buy property from Amy.

3. Different Compliance Requirements Apply to Residential and Commercial Investment Properties

There is some leeway in how you can put your self-managed super fund's commercial property to use, despite the fact that the SMSF compliance rules must be followed in order to purchase any property, regardless of whether the property is residential or commercial.

Take for instance the scenario in which you are a participant in an SMSF. If this is the case, you are permitted to utilise the self-managed super fund to invest in the commercial property that serves as the location of your firm, so long as the majority of the space in the building is dedicated to the conduct of business-related activities.

It is important to keep in mind, however, that an SMSF cannot invest in the real business that you run.

Your company will consequently take up residence in the office space that is owned by the SMSF as a tenant. You will be paying rent, but it will be contributing to your self-managed super fund (SMSF) because the commercial rent that you pay for the business premises will be deposited there immediately.

4. When You Borrow Money, SMSF Requirements Must Be Followed

Even while self-managed super fund regulations let you to use a house loan to pay for the property you want to buy, the process of purchasing real estate is still governed by self-managed super fund property investment restrictions.

You are required to set up a limited recourse borrowing arrangement (LRBA) in order to borrow money for the real estate held by your self-managed superannuation fund.

In order to safeguard the other assets held within the SMSF, you will be required to establish a separate trust as part of the limited recourse borrowing agreement.

The property investment is held by the independent trust rather than within the structure of the SMSF. Even though all of the revenue and costs from the investment property will still be routed through the bank account of the superfund, the investment property itself is just held on the SMSFs behalf by another trust structure.

Imagine that the SMSF is unable to make the required loan repayments. Due to the limited recourse borrowing arrangement, the lender is only permitted to reclaim the separate property trust in the event that this occurs; they are not permitted to reclaim any other assets held by the SMSF.

5. Rules for Taxation of SMSFs

The favourable tax rules are one of the most prevalent motivating factors that leads investors to purchase property with the help of their SMSF:

• 15% is the marginal tax rate that applies to income from investments
• You won't be required to make tax payments on your rental income once you reach the pension stage and are able to access your retirement savings. The rental revenue that the fund receives once you are able to use your funds for retirement is tax-free
• When you sell investment properties that have been held in the super fund for more than a year, you are eligible for a capital gains tax (CGT) discount. This means that the amount of capital gains tax that you are responsible for paying will be reduced to 10%
• The loan interest paid by the SMSF for the investment property can be deducted from taxable income.

The Good And The Bad

The purchase of real estate could seem like a good plan for an SMSF, but first, the potential benefits and drawbacks need to be carefully assessed.

Pros

• Tax-effective. Earnings are subject to taxation at a rate of 15%, which is typically a significant reduction over the amount you would be required to pay on investments held in your own name.

• A discount is applied to the tax on capital gains. A one-third reduction will be applied to any capital gains realised from the sale of a property that has been held for more than a year. This results in the capital gains tax burden being capped at 10 percent at most. In addition, if the sale takes place when the SMSF is in the pension phase, then there is no tax liability associated with the sale.

• Putting together a strategic plan. Your Self-Managed Superannuation Fund (SMSF) enables you to buy commercial real estate and then rent it out to your own company, with the proceeds going into your SMSF.

Cons

• No personal benefit. Every transaction involving real estate must be conducted at an arm's length. You are not permitted, for instance, to buy from, sell to, or rent to a member of your family or another linked party.

• Renovation restrictions. If there is still a loan on the property after it was purchased with an SMSF, you will not be able to do any renovations.

• Few tax advantages available. If you take out a loan to purchase a property and end up with a negative equity position, the tax offset will only apply to other income earned within the fund; it will not apply to any income you receive outside of the SMSF.

Rental Property Held Within an SMSF

What trustees of a self-managed superannuation fund (SMSF) may and cannot do with the real estate that the fund has purchased is governed by a complex set of laws and regulations. One rule that is taken very seriously is to prevent members' relatives or other linked parties from profiting from property purchases.

For instance, a residential property owned by an SMSF cannot be rented out to a member of the same family because this would be in violation of the laws governing superannuation. An SMSF, on the other hand, has the ability to purchase an investment property that is rented out to tenants who are neither members of the fund nor connected parties.

It is possible for an SMSF to buy a commercial property, then rent it out to a member's company at current market rates, with the rent money going into the SMSF. This is because commercial property is evaluated differently than residential property. This is a common approach that enables the self-managed super fund (SMSF) to accumulate funds through the use of business rentals.

Renovating Properties Owned by SMSF

When contemplating the renovation of a property owned by an SMSF, care must be given because the manner in which the property was acquired affects whether or not the renovation can be completed.

If the SMSF takes out a loan to purchase the property, it will have some limitations placed on its actions, particularly if the loan is still being paid back. You are only allowed to make changes or renovations to the property that do not fundamentally alter the nature of the real estate if the loan is still active.

One more thing to keep in mind is that SMSFs are not allowed to use borrowed money to finance renovations; however, they are allowed to use borrowed money to finance repairs. Because of this, it is essential to have a good understanding of the distinction between a "upgrade" and a "repair."

An SMSF may use its own money to fund renovations if it has sufficient cash at its disposal.

If, on the other hand, the trustees paid cash for the property, they have complete freedom to decide how they will use it, including whether they would subdivide it, renovate it, or develop it, provided that the trust deed allows for such actions.

Selling SMSF Real Estate

In most cases, an SMSF will not be able to purchase a property from a member; however, an SMSF will be able to sell a member's property. However, the law mandates that this transaction take place between parties who have no financial or other ties to one another, that the property be accurately appraised, and that the purchase price be proportional to the property's value on the market.

A SMSF may invest in residential or commercial real estate, including properties located in other countries. When it comes to the latter, however, trustees need to take into consideration the regulations of that nation, particularly those that address how a non-local company, in this case an SMSF, can legally hold property there.

Any transactions involving purchasing and selling property need to be authorised by the trust deed and the investment plan of the self-managed superannuation fund (SMSF), just like other fund assets.

FAQs

1. Can I occupy my SMSF property as a home?

Even though you are not permitted to live in a residential property that is owned by your SMSF, you are still able to get ownership of the property once you reach retirement age.

Nevertheless, let's say that the land in question is used for economic purposes, such as a farm. If this is the case, then a member is allowed to reside there provided that certain conditions are met, such as their stay being incidental and relevant to the activities of the firm.

In addition, the residential area of the land cannot be larger than 2 hectares, and the property should not be used for domestic purposes to a significant extent.

2. When I retire, am I allowed to live in the property that is held by my SMSF?

After you retire, the only way you will be able to reside in a property owned by your SMSF is if the property has been transferred into your name.

After you have reached retirement age, you will have the ability to complete what is known as a "in-specie" transfer of the property to you. This involves changing the title of the property from the SMSF to your own name.

Be aware that the fund must have purchased the property only if it was a sound investment for the fund and if it was in line with the fund's investment plan. The fund cannot have purchased the property with the aim that it will serve as your or another member's retirement home.

3. Can I sell the property owned by my SMSF to myself?

If the transaction is conducted at market value on an arm's-length basis, then it is conceivable to get this result. In order to demonstrate that the acquisition price is consistent with the market worth, you might need an impartial valuation. Depending on the state or territory in which you now reside, you may be required to pay stamp duty.

Make it a point to refrain from using the property for any personal endeavours in the time leading up to the sale, at least not until the title has been successfully transferred.

4. How much money can an SMSF borrow to purchase a home?

It's possible that your SMSF won't have enough cash on hand to pay for the home outright, in which case you'll need to apply for a loan. The amount of money that an SMSF is able to borrow will change depending on the kind of property and the lender.

Because the borrower may only put up the property itself as collateral for this kind of loan, the lender views it as a higher risk. As a result, the maximum amount that can be borrowed is often capped at 65 percent of the total amount needed.

When compared to the more typical down payment requirement of 10% for homes purchased outside of an SMSF, your deposit would most likely need to be significantly greater - sometimes up to 35%.

5. Can a little SMSF build a property?

It is conceivable to do this, but there are several restrictions, particularly around breaking any tax or super rules. The self-managed superannuation fund (SMSF) must not fail the only purpose test, which stipulates that the fund's only objective should be to provide income for retirement and not revenue for immediate use.

If you choose to outsource the actual development of the property, however, your self-managed super fund (SMSF) is merely providing financial support for the endeavour. As a result, there ought to be less of a challenge associated with taking this activity.

6. Is it possible to pay off your mortgage with the money from an SMSF?

Every member is accountable for the decisions made by the fund as well as for ensuring that it complies with the applicable tax and superannuation rules. If you withdraw money from the SMSF for a purpose that is not permitted by the regulations, you may be subject to severe penalties.

However, in order to access your retirement savings, you will need to satisfy a condition of release, which is typically satisfied by demonstrating that you are experiencing severe financial hardship. You are not permitted to withdraw money from your SMSF to use it to pay for personal expenses such as a mortgage if you do not fulfil the requirements for release.

Key Takeaways 

The freedom to dictate investment strategies and make purchases of investment property via a self-managed super fund is an appealing choice for many property investors. This is in addition to the advantageously lower tax rate for high-income earners, which is another benefit of this option.

On the other hand, the ATO has established a number of stringent regulations in order to safeguard your financial and retirement interests that are vested in the SMSF.

Your selections about investments should always adhere to the investment strategy that you have established based on the sole purpose test. Whatever choice you end up making, you absolutely must do it with your retirement benefits in mind.

Before you get started with self-managed super fund (SMSF) property investing, you should talk things over with a financial advisor because there are a lot of complicated compliance laws.

In addition, after you have decided to move forwards with your investment strategy, we recommend that you also speak with a tax professional who will assist you in making the most of the tax benefits that are open to you.

Our principal mission is to provide assistance to real estate investors by assisting them in maximising their prospects and safeguarding themselves while lawfully reducing their tax obligations.

Get in touch with us as soon as possible to discuss anything relevant to self-managed super funds property investment rules and to organise your affairs so that you pay the least amount of tax possible.