For many investors, a popular way to invest directly in residential or commercial property is through their self-managed super fund (SMSF). In fact, ATO statistics show property is the third most popular asset class in SMSF portfolios.
Part of the attraction of holding investment property within your SMSF is the concessional tax rates applying in the super system, with rental income taxed at only 15% – or nil if the fund members are in the pension phase. As with property investments outside the super system, rental property expenses are tax-deductible and if the property is owned for more than 12 months, any capital gain is taxed at a discounted rate of 10%.
Purchasing residential property
While it is possible to purchase residential property through an SMSF, there are strict regulations that must be met.
Residential property purchased through an SMSF cannot be lived in by any trustee or anyone related to a trustee, regardless of the relationship. The property can also not be rented by a trustee or relative of a trustee. This means that under no circumstances can a trustee use property purchased under an SMSF for their personal accommodation. SMSF residential property can still be rented at market rate to a person unrelated to a fund member.
Existing residential investment property owned by any fund member cannot be transferred to or purchased by an SMSF.
Purchasing commercial property
There are typically more advantages to purchasing commercial property under an SMSF over residential property. Many small business owners purchase commercial property through self-managed funds as a lucrative investment, providing that strict compliance requirements are met.
Unlike residential property, commercial property can be sold to an SMSF by fund members and leased to trustees or relatives of trustees, however there are still regulations in place. The property must be used exclusively in a business and the purchase price and rent paid must be market value. The investment must also satisfy the overall function of the fund, being to provide retirement benefits to its members.
Borrowing to purchase property
In general, SMSFs can’t borrow to buy an investment asset. The only exception to this is via a limited resource borrowing arrangement (LRBA).
With an LRBA, the SMSF has a beneficial interest in the property but it is owned by a separate security trust, commonly referred to as a bare trust. If the loan defaults, the lender only has recourse to the property, not the SMSF’s other assets.
LRBAs are complex borrowing arrangements with strict loan conditions that are different to a normal mortgage. If structured incorrectly, the borrowing exemption lapses and the SMSF will have breached the super rules.
Loan repayments must be made from the SMSF, meaning that the super fund must always have money available to meet repayments.
Tax considerations
SMSFs are required to pay 15% tax on any rental income from property. On property held for longer than 12 months, a one-third discount is received on any capital gain made upon sale.
Interest payments on an LRBA are tax deductible to the fund. If expenses incurred exceed fund income, a taxable loss is carried forward and used to offset future taxable income.
Renovations, maintenance and improvements
General repairs and maintenance of the property may be paid for by the SMSF but any improvements that significantly alter the investment are tricky to manage and advice should be sought before proceeding.
Significant improvements or renovations to the property can only be paid for by fund money unless they are paid for by the tenant as a leasehold improvement for their business. Furthermore, renovations that substantially change the property or asset under an LRBA will require a new loan arrangement.
If you’re interested in purchasing property through an SMSF and not sure where to start, Optima Partners can help. Our dedicated SMSF team assists more than 250 funds with their compliance obligations and we make the process as seamless as possible.
Contact us today and we’ll pair you with the right SMSF accountant for your needs.
