Purchasing a property using a self-managed superannuation fund (SMSF)

Many people like to invest in property. In these uncertain times, investing in listed shares or managed funds can often seem too risky. In contrast, the returns from term deposits or other fixed interest securities is historically low.

Given that background, many people turn to property as a suitable investment. Property investment can be undertaken using your super, utilising a self-managed superannuation fund (SMSF).

What is a SMSF?

A self-managed superannuation fund is just that – it is a fund you manage yourself. With a few minor exceptions, all members of the Fund must be either individual trustees or directors of a corporate trustee. It is this requirement that ensures that the members have control over their own super.

Under the legislation, a SMSF is limited to a maximum of four members. However, most funds have two members – so called “mum and dad” funds.

Using a SMSF can be a very useful and tax effective vehicle in which to purchase property. There are however a number of special rules that trustees of the superannuation fund need to be aware of to ensure that it complies with the regulatory guidelines.

The following is a summary of the various forms of property that can be invested in a SMSF and some tips to ensure that the purchase of the property is suitable and correctly implemented.

Residential Property

A residential property can be purchased within a SMSF and a number of our clients do just that.

Importantly though, any residential property held by a SMSF cannot be purchased from a member of the fund or a related party. In addition to this, a residential property owned within a SMSF cannot be rented to or used by a member of the fund or a related party.

Commercial Property

Another common form of property that our clients purchase within their SMSFs is commercial property.

Unlike residential properties, commercial property (or business real property) can be purchased from, and leased to, a related party.

If transacting with a related party, valuations are required to ensure that all transactions (purchase and/or lease) are on arm’s length terms (at market value).

Options for holding property in your SMSF

There are a number of ways in which a SMSF can hold property. One is as “tenants in common” with another party, most often a related party. For example, if you wished to purchase a property for investment purposes, but did not have enough money outright in your own name, you could utilise your superannuation savings by using a SMSF to purchase the property as a tenant in common with yourself, in any proportion required.  This is an alternative to borrowing the funds you may need to purchase the property.

In these circumstances, as a SMSF is a part-owner of the property, it is important that all the superannuation rules relating to property investment are met. For instance, if the property is residential, then no related party may rent, reside in or even stay in the property. If the property is commercial, then a related party can lease it, but it must still pay rent to the SMSF in proportion to its ownership, on arm’s length terms.

Borrowing to Purchase Property

All superannuation funds, including SMSFs, are generally prohibited from borrowing. The idea is that borrowing increases risk, and can potentially put hard-earned superannuation savings in jeopardy. However, one exception to this rule is that a fund can borrow to purchase an asset, including property, using a “limited recourse borrowing arrangement” or LRBA.

Under the LRBA rules, the trustees of an SMSF can borrow to acquire an investment, but must do so through a separate trust, often known as a borrowing trust, or a bare trust. The legislation ensures that if there is a default on the loan, only the assets held in the borrowing trust are at risk, and the lender has no recourse to the other assets of the SMSF.

The legislation that permits LRBAs is detailed, and there are many traps and pitfalls to avoid in setting them up. In addition, the Australian Taxation office (ATO) has issued a number of rulings and guidelines relevant to LRBAs. If you are going to purchase a property (or any other asset) using a SMSF and LRBA, you should look to obtain specialist advice from experts in the field.

Get in touch with our SMSF Specialist team on 1300 363 866 to find out more.

McConachie Stedman Financial Planning is an Authorised Representative of Wealth Management Matters Pty Ltd ABN 34 612 767 807 | AFSL 491619