Investing in property through a Self-Managed Super Fund (SMSF) has become a popular strategy for Australians looking to build wealth for retirement. Buying an investment property through a SMSF is generally considered a lower risk investment choice compared to other options (if you make a careful and considered choice) because of the potential for long term capital growth and the regular rental income flowing into the SMSF can really set you up for retirement.
If this is something you are considering, you must make a careful and informed decision as the industry is highly regulated, and there are strict rules around how property investments can be made within an SMSF.
Who can buy property through an SMSF?
It may come as a surprise that not everyone is suited to buying property through an SMSF.
Individuals who want to invest in property through their SMSF would need to be willing to take on the compliance responsibilities of SMSF trustees, ensuring that their fund remains complaint with the super laws, reporting needs, and tax obligations.
It is recommended that the SMSF generally needs to have a minimum balance of $250,000 to be able to purchase a property and an annual contribution of at least $15,000.
Ideal candidates would be:
- High superannuation balance – Experts recommend an SMSF should have at least $250,000 to $500,000 in assets to be cost-effective.
- Experienced Investors – Those with a solid understanding of property investment and SMSF regulations will be better equipped to manage the complexities involved.
It might also be an appropriate choice for: - Business Owners Wanting to Buy Commercial Premises – This allows them to lease the property to their business while benefiting from rental income.
How to use your SMSF to buy an investment property:
You can purchase an investment property through your SMSF by getting a loan to purchase the property. Your superannuation contributions will then go towards paying the interest on the loan.
The expenses for your investment property will be paid by the fund, so will not be out of pocket for you.
Can I use my SMSF to buy my home?
Simply, the answer is no. This is because it does not pass the restrictions of residential properties purchased in an SMSF. There are restrictions in the types of properties that you can purchase.
Residential Property:
An SMSF can be used to buy a residential property if it conforms with the several restrictions associated, which are:
- A trustee, or anyone related to the trustee, cannot live in a residential property that you have purchased through the SMSF.
- A trustee, or anyone related to the trustee, cannot rent the property purchased through the SMSF.
- The SMSF cannot buy a property owned by a trustee or anyone related to the trustee.
- The purchase must meet the ‘sole purpose test’ of solely providing retirement benefits to fund members.
The object of the ‘sole purpose test’ is to ensure that the SMSF is used for the sole purpose of providing benefits to members upon their retirement or their dependants in the case of the member’s death before retirement.
There is also a restriction that, you cannot absorb an existing residential home that a trustee owns into the SMSF by purchasing it.
Commercial Property:
Commercial property is a popular choice for SMSF investors, but it is still bound by the same restrictions as buying residential properties, including the sole purpose test.
There is one interesting benefit for buying a commercial property through SMSF, which is that you are able to buy commercial property through an SMSF and lease it back to yourself by paying rent to the SMSF. This a relatively common choice for small and medium-sized enterprises (SMEs).
The main test is that it is maintained on an ‘arm’s length basis’, meaning that all investments should be managed on a strictly commercial basis, with the assets reflecting their true market value.
As well as the sole purpose test, there are several other conditions:
- The terms of the lease must be commercially competitive and/or market value. You can’t give your business mates’ rates and lease the property for way less than it’s worth on the market to yourself to save yourself money.
- You’re required to get regular valuations on the property to ensure the rent you’re paying is the appropriate market value.
- You must pay your rent on time, in full, every time. The conditions must be just like in any other rental agreement.
Failure to follow these conditions will result in your lease not being compliant. SMSFs are monitored by the ATO who regularly audit them to ensure compliance. Additionally, SMSFs are required to audit themselves annually.
Rural or Industrial Property – Similar to commercial property, an SMSF can acquire farmland or industrial premises as long as they meet the investment criteria and are not used for personal purposes.
What You Cannot Buy Through an SMSF
There are clear restrictions on the types of property an SMSF cannot purchase:
- Owner-Occupied Residential Property – An SMSF member or a related party cannot live in or rent the property owned by the SMSF.
- Holiday Homes for Personal Use – A SMSF member or a related party cannot use a holiday home owned by the SMSF for personal holidays.
- Development and Renovation – The SMSF is meant for long-term wealth-building, so properties cannot be acquired with the intention of renovating and selling them for a short-term profit.
- Land for Immediate Personal Development – Purchasing land with the intention to build and later use for personal purposes is prohibited.
Other restrictions to be aware of:
- Borrowing Restrictions – SMSFs can borrow to purchase property through a Limited Recourse Borrowing Arrangement (LRBA). However, these loans have strict conditions, including the requirement that the property must be held in a separate trust until the loan is repaid.
- No Direct Personal Benefit – Members or their relatives cannot live in or use the property, even temporarily.
- Liquidity and Diversification Requirements – The SMSF must maintain enough liquidity to cover expenses and should not be overly concentrated in property, as trustees have a duty to diversify investments where possible.
- Renovation Limits – If an SMSF borrows to buy property, it cannot make significant alterations while the loan is in place. Only maintenance and minor improvements are allowed.
Benefits of buying property through a SMSF:
Tax advantages:
Rental income is taxed at a concessional rate of 15% (or 0% in pension phase), and capital gains tax is reduced to 10% if the property is held for more than 12 months. There are also negative gearing benefits.
Leasing to Your Business – Business owners can purchase commercial property through an SMSF and lease it back to their business. This can secure long-term premises and providing rental income into the fund.
Long-Term Wealth Growth – Property can provide consistent rental income and capital appreciation, growing the retirement savings over time.
Asset Protection – Assets held within an SMSF are generally protected from creditors if a member faces personal financial difficulties.
Control– SMSF trustees can directly manage investment choices, including property selection and lease agreements.
Cashflow– Expenses for your investment property will be paid for the fund, and will not be out of your own personal pocket.
Drawbacks of buying property through a SMSF:
Access to funds– you won’t be able to gain immediate access to any of your rental income or capital gains as this stays within the fund. All profits flow back into the SMSF and can be re-invested and only accessibly when you retire.
Higher costs – SMSF property loans tend to be more costly than other property loans.
Cash flow – Your fund must always have sufficient liquidity or cash flow to meet expenses. These may include the loan repayments, insurance premiums for the property and other property expenses such as rates or property management. The fund may also need to allow for retirement pension payments or lump sum withdrawals.
Loan balance – You need to ensure there is a strategy in place to repay the loan in the event of illness, disability or death of members, or rental vacancy.
Difficult to cancel – If your SMSF property loan documents and contract aren’t set up correctly, you can’t unwind the arrangement. You may have to sell the property, potentially causing substantial losses to the SMSF.
Tax losses – You can’t offset tax losses from the property against your taxable income outside the fund.
Restricted, no renovations or alterations – You can’t make alterations that change the character of the property until you pay off the SMSF property loan.
Compliance– SMSFs must comply with numerous ATO regulations. Failure to do so can lead to penalties, loss of tax benefits, or even the fund’s disqualification.
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