Self managed super funds now gearing into the property market

Editorial – July 2010

Many investors know the attraction of negative gearing for property investment. Now super rules have opened up the way for self managed super funds to access this powerful investment strategy.

“It's not that surprising that those who like the direct control of self managed super are often also very interested in the benefits of gearing into property investment. Super rules now allow self managed funds to borrow and this has opened up the opportunity to use gearing to buy direct property assets as part of their SMSF portfolio”.

Guidelines on how the borrowing and purchase are arranged are strict, but as long they are satisfied and the purchase suits the overall fund investment strategy, it can be a highly rewarding and tax efficient option to build retirement assets.

A tax effective strategy
“Rental income generated from your property investment is normally taxed at marginal rates, but within a SMSF it will only be taxed at the superannuation tax rate of 15%. Furthermore, if sold before retirement, the property proceeds will generally only attract capital gains tax at the rate of 10%. After retirement there is no capital gains tax liability and no tax on rental income from the property.

Add to this the normal tax deduction opportunities that gearing offers on property upkeep and you have a very tax effective strategy to complement other investments within your super fund”.

Apart from the tax advantages, many are simply attracted to having the direct control and freedom of a 'hands-on' investment, where they can get involved in finding and buying a property and see a tangible asset that is growing in value towards their retirement.

“When a business already owns a commercial property, what they can do is have their self managed super fund buy the property from their business - which in turn frees up cash within the business to invest in more productive ways. It's a very neat solution”.

A structured approach is essential
The many benefits of this strategy need to be tempered by a rational approach to how it is implemented. The guidelines are strict and the penalties for non-compliance are severe.

“My first priority when advising clients is to impress upon them that this is a far more complex situation than normal property investment gearing, in terms of the borrowing and ownership structures that are required. It is vital to involve their legal and accounting advisers in the process and follow a carefully mapped out sequence to make sure it is above board”.

While the suitability of the strategy will depend on individual circumstances, the basic steps involved in implementation and keeping within super regulations can be summarised in the following key steps:

• Engage an adviser to manage the process and co-ordinate legal and accounting involvement
• Check that the fund's Trust Deed permits borrowing and has a stated strategy that will accommodate direct property investment
• Establish a separate instalment warrant and a security trust arrangement – this is the approved mechanism enabling the SMSF to invest directly in property
• Consult with your financial adviser on an appropriate level of existing fund assets to be directed into the property purchase
• Source lending that complies with SMSF borrowing rules - specifically, in the event of default, the lender can only claim on the property itself and not other fund assets.
• Negotiate the property purchase
• Arrange ongoing procedures – the SMSF will service the loan and will directly collect interest on the property. Regular review, valuation and tax reporting will be required to maintain compliance with regulations

The selection of property is something that obviously is of great interest to those who can access this strategy. It is critical to have an appreciation of the rules and what is permissible. “Investors can choose either commercial or residential property, but residential property cannot be bought from a related party, such as another family member. If it is a commercial property purchased from a related party, then the valuation and rental rates must be commercial levels so that the fund is not disadvantaged.”

“The opportunities are great but the obligations are serious, so get advice from someone who knows the territory”.

If you are interested in exploring property investment through your SMSF, contact Hugh Kilpatrick from Reservoir Office on 03 9471 0080 or service@rireservoir.com.au for further information.


*Hugh Kilpatrick is an Authorised Representative of RI Advice Group Pty Limited (ABN 23 001 774 125), Australian Financial Services Licence 238429. This editorial does not consider your personal circumstances and is general advice only. You should not act on any recommendation without considering your personal needs, circumstances and objectives. We recommend you obtain professional financial advice specific to your circumstances.