Superannuation legislation allow self-managed super funds (SMSFs) to borrow to invest, providing certain conditions are met. If you have an SMSF, you may be able to use these arrangements to help buy an investment property through your fund.
Property investing with debt
Like any property investment that uses a leveraging strategy, an SMSF can use borrowed funds to acquire a property with a larger
purchase price then the assets currently available. The SMSF can purchase the property under a Limited Recourse Borrowing Arrangement (LRBA) (i.e. in the event of default, the lender only has recourse to the property and cannot claim any other SMSF assets).
In this scenario:
• The SMSF makes a partial payment on the property, and borrows funds to pay the balance plus other acquisition costs – using the property as security under a ‘limited recourse’ loan.
• The property is held in a trust for the SMSF, which is entitled to the rental income and responsible for paying the expenses relating to the property.
• The SMSF pays off the loan over the agreed period.
• After the loan is repaid, legal ownership of the property can be transferred to the SMSF.
How the strategy works
This strategy allows your SMSF to acquire property that’s worth more than what is available in the fund, by repaying multiple instalments over the long term.
This arrangement offers some advantages:
Your SMSF receives all income and capital growth from the property, even if the property has not been paid off.
• Your SMSF can use income from the property and future contributions to help pay off the loan.
• Interest expenses may be claimed as a tax deduction by the SMSF and potentially reduce your SMSF’s tax liability.
• Because the property is purchased using a limited recourse loan, the lender only has recourse over the property itself – meaning the other assets in the SMSF are secure in the event of default.
• Income after expenses and any capital gain on disposal may be taxed at lower rates (i.e. 0%-15%) in the hands of the SMSF.
Different rules for commercial and residential
A SMSF can invest in either commercial or residential properties and the Trustee is responsible for determining what would be the most appropriate investment for the Fund. SMSFs are restricted from acquiring from or leasing fund assets to related parties, however there is an exemption to this rule where the property is used exclusively for business purposes.
Therefore:
• Residential property must be acquired from an unrelated party and cannot be leased to related party of the fund or fund members.
• Commercial properties that are used 100% exclusively for business purposes can be acquired from a related party as long as it is at market value.
• Commercial properties can be leased to related parties for business purposes at market rent.
• The Trustee is responsible for ensuring the market value and market rent is appropriately determined and they maintain which supports these values.
Things you should consider
There are a number of complex rules and regulations around buying property inside an SMSF, so it’s important to seek professional financial, legal and tax advice specific to your circumstances.
Some of the key things you should consider include:
• Your SMSF trust deed must allow borrowing.
• A legal professional should establish the trust structure to ensure it meets certain conditions.
• Investment in property must be consistent with your SMSF’s investment strategy and in the best interest of its members.
• Your SMSF must have the ability to service the debt and cover operating costs of the SMSF.
• The property is held in the Fund financial accounts at market value.
• Life insurance for members must be considered and noted, so that in the event of permanent disability or death, the member or their beneficiaries can be paid without the need to sell the property.
• Unpaid borrowings from LRBAs established after 30/6/2018 affect the total superannuation balance of individuals who have met a condition of release. This could have an impact on the members ability to make contributions and pension planning.
Strategy in action
Suppose your SMSF has $250,000 in the cash account. As the SMSF trustee, you want to buy an investment property worth $600,000.
If you buy the property on behalf of your SMSF under an LRBA, you can use $220,000 (allowing for a 5% cash buffer of $30,000) to make an initial payment for the property. The shortfall of $380,000, plus $40,000 in stamp duty and acquisition costs, is funded by a limited recourse loan – using the property itself as security.
You then arrange for the property to be leased at market rates. The rent, together with other SMSF income and/or employer / member contributions, are used to make interest and loan repayments. Once the loan is paid off, legal ownership of the property can be transferred to the SMSF.
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