Useful Tips
There are several important factors that you must consider, discuss and explore with your professional team before considering recommending property as an investment through an SMSF.
| FACTOR | ISSUES TO CONSIDER |
| Establishing an SMSF | You should not choose to establish an SMSF simply because you want to invest in property without proper consideration of all the risks, benefits and associated costs involved.
An SMSF can allow greater control, broader flexibility in choice of investments and other estate planning benefits compared to alternative superannuation structures. However, it also requires the trustee to devote time, skill and prudential responsibilities, including compliance with a range of legal obligations to ensure the fund remains compliant. |
| Investment strategy | Does the SMSF investment strategy allow for the investment into direct real property?
An investment strategy must be prepared and implemented for an SMSF to ensure compliance with the SIS Act and regulations. The investment strategy should demonstrate the purpose for the investment and considerations of the associated risks.
The SMSF trust deed must specifically allow for borrowings if the trustees intend to acquire property using finance. |
| Restrictions on the acquisitions of assets | The property cannot be acquired from a related party of a member of the SMSF unless the property satisfies the definition of ‘business real property’. If it doesn’t satisfy this definition, then it must not be rented or lived in by a member of the fund or any of the member’s related parties.
In this case where the property is business real property, then the rent can be paid from a related party directly to the SMSF at market rates |
| Risk | Buying any property involves risk so it is important that appropriate due diligence is undertaken before any decisions are made. Possible risks include:
• valuation risk – which may require a larger deposit to be paid • occupancy risk – a loss of tenant or no tenant may impact the SMSFs cash flow and ability to meet other liabilities as they fall due; and • borrowing risk – potential interest rate rises (or rent decreases) may impact the ability of the SMSF to meet loan repayments. |
| Diversification | The high cost of an individual direct property may mean that the SMSF is heavily weighted in one asset class. Trustees are also obliged to consider diversification as part of their investment strategy within the SMSF.
Diversification also helps limit investment risk if any one asset class underperforms. |
| Return | While property is a growth asset and traditionally outperforms inflation, it cannot be assumed that the returns made by many through investing in property in the past will emulate what happens in the market in the future.
If the property is the dominant asset within the fund, will it be able to generate adequate investment returns to fund your retirement? |
| Liquidity | If the property is going to be the main asset of the fund, you (i.e. the trustees) will need to ensure that there is sufficient liquidity to meet its liabilities such as loan repayments, fees, insurance premiums, taxes and the payment of member benefits such as pensions and death benefits.
You may need to do this via accumulation of additional liquid investments and possibly putting appropriate life insurance policies in place for members to protect against unplanned death benefit payments. |
| Costs | There are a variety of fees involved when initially purchasing property including valuation, legal, stamp duty and bank fees. There may also be advice fees and ongoing management fees. These fees will increase the overall cost of the initial property and must be carefully considered when structuring a property purchase transaction.
There will also be many other ongoing running costs such as maintenance, repairs, rates and insurance for example. Building and Landlord insurance may also be necessary to protect the investment. These costs are in addition to the normal costs of running the SMSF itself. |
| Legal obligations | It is important when purchasing property that all required documentation is completed and executed in the correct manner. The SMSF must be established before the contract to purchase the property is signed. It is important that the correct names are on the title of the property and all other documents are checked, to avoid common errors resulting in property titles being registered in incorrect names.
Geared property cannot be owned directly by the SMSF, rather the property must be legally owned by a separate holding trust where the SMSF is the ‘beneficial owner’.
It is very important to ensure all required documentation is prepared and executed properly and in compliance with the relevant legislation, as failure to do so can result in significant associated costs to unwind arrangements and redo contracts. |
| Tax considerations | There are a number of tax advantages of purchasing property within in an SMSF. This includes a maximum tax rate 15% on net rental income in accumulation mode and 0% when in full pension mode.
Further, where the property is sold after being held for more than 12 months any resulting capital gain will incur a maximum 10% capital gain tax rate or 0% if in pension mode.
However, for some it may in fact be more tax effective to purchase the property in other structures or their own name instead of via a SMSF. |
| Alternative structures | When purchasing property consideration should be given to alternative structures, such as unit trusts and joint ventures. |
