What are the benefits?

The major benefit of having property through super is it can be very tax-effective. You can tap into concessional tax rates on the income you receive as rent – or, if you are in the pension phase, even pay no tax.

You will also pay less capital gains tax (CGT) if the property is sold – just 10 per cent on realised capital gains when in accumulation mode, compared with your marginal tax rate outside super, which can be up to 45 per cent, plus the Medicare levy. Plus, the ability to borrow in an SMSF means you can purchase an investment property inside the fund, using some of the super balance as a deposit, and keep the Loan-to-Valuation Ratio (LVR) at an acceptable level.

It is also possible to buy the commercial property through which you run your business. This provides the fund with a good tenant (your business), whilst the business also gets a great landlord (your SMSF). Rent paid is tax deductible, so, in essence, your business gets a tax deduction for paying rent to your SMSF.

What are the risks?

As a long-term investment, property can be a strong performer both in terms of yield and capital growth. However, past performance is no guarantee for future performance and individual properties can provide markedly different investment returns.

Also, yield expectations can often be higher than the reality, particularly after taking initial and ongoing costs and rising property prices into account. There is also the risk of downtime between tenants, or that damage or essential maintenance means the property sits empty for a period.

If a member of the fund dies, property can also make paying a death benefit more complex. For example, if a member dies, and the benefit is being paid to a non-dependant adult child, the property will potentially need to be sold and depending on how it was contributed to the fund, there may be a lump sum payable at the rate of 15 per cent, plus Medicare Levy. Outside the superannuation environment, there may not be a requirement to sell the property. Property may be transferred in specie to a beneficiary, but there may also be stamp duty implications to contend with. Some jurisdictions have a stamp duty exemption if the property is transferred to the member or members.

How can the property be used?

Residential property held by the fund cannot be used by you or a related party such as a relative. So, that holiday home is out of the equation if you ever want to stay in it yourself.

On the other hand, commercial property can be used by you or a related party exclusively for business purposes – provided you pay market rates of rent.

Can I transfer my existing property into my SMSF?

Residential property you already own usually cannot be transferred into your SMSF. That is because SMSF rules prevent the fund from acquiring an asset from a fund member or related party.

However, business real property can usually be moved into your fund, but you may be liable for CGT and potentially stamp duty at the time the property is transferred (again, seek advice as exemptions may apply).

Can my SMSF borrow to invest?

As mentioned previously, an SMSF can borrow to buy investments for the fund – including property. There are no set limits on how much you can borrow, but the LVR should be around 60 to 70 per cent, to make the arrangement manageable. Also, the fund can borrow money from a member, or relative of a member, but the loan terms must satisfy the safe harbour provisions to ensure extra tax is not incurred (more on this in a future SMSFs and property topic).

One of the advantages of borrowing through your fund is it is a ‘limited recourse’ lending arrangement. If you default, the lender only has recourse to the property purchased by the loan – not the other assets in your fund. They may require personal assets to be used as collateral, however.

While the loan is in place, ownership of the asset is held ‘in trust,’ with the SMSF holding a beneficial interest. When the loan is paid off, ownership ordinarily passes to the SMSF.

Conclusion

Investing in property through your SMSF can be a great way to build your retirement savings nest egg, via investment in an asset class we all know. Real property is a distinctly tangible asset, and some people just feel comfortable knowing exactly what they have invested in. Nonetheless, purchasing property through your SMSF has limitations compared with purchasing property in other entities. There are strict rules, some of which we have covered in this first paper on SMSFs and property.