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andrewcrossley  x

The pros and cons of SMSF investing

andrewcrossley  x
Andrew Crossley 6 minute read

In recent years there has been considerable publicity regarding purchasing residential property in a self-managed super fund.

This structure is only for some. It does have the advantages of the ultimate asset protection, and tax relief. However, for these tax benefits to be relevant, the property is locked away until the beneficiaries are of an acceptable age.

It is generally considered important that the fund retains liquidity (i.e. holds assets such as cash and securities that can be quickly converted to cash), so a good balance of liquid assets as well as a property may be wise.

A good accountant may have the view that if residential property is to be held in a self-managed super fund, the deposit should be large enough to ensure that the property is positively geared, particularly when the limits for contributing to the superfund are capped at such a low level. This level will be increasing from $25,000 per annum to $30,000.

Rules governing SMSFs are always changing. The advantages of having an SMSF are dependent on many things.

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Since the mid-1980s, people have wanted greater autonomy in managing their superannuation fund. As of the mid-‘80s, people have been able to set up and manage their own self-managed super fund, allowing them to make their own investment decisions and, in turn, hopefully providing the necessary returns for each member as they approach retirement. Tax concession benefits provide income for retirement to each member’s benefit, as they do in a normal superannuation fund, so it is not the reason why someone would set up an SMSF.

SMSFs have become very popular over recent years for a number of reasons. Most recently, it is the ability to purchase property in the fund. John Howard abolished the ban in 2007 preventing people from borrowing money in their SMSF to invest. Members of their own SMSF can acquire and hold real estate, whether residential or commercial.

Other reasons for SMSFs' increasing popularity that have been around a lot longer may include the potential of it being more cost-effective to have your own fund, because some larger superannuation funds charge very high fees. The Superannuation Industry (Supervision) Act’s requirements may be more beneficial to some people when compared with some other funds. Members can have control over the decisions of the fund, and finally, people may believe they can achieve better results when they can manage the fund themselves, compared with the poorer returns on investment achieved from some other larger funds. Again, this is debatable.

The Australian Taxation Office is increasing its compliance activities due to the growth of the SMSF sector in Australia in recent years. ASIC is also vigilant as there are many spruikers taking advantage of people. There are also many individuals and companies providing advice when they are not licensed to do so.

Advantages and disadvantages of holding property in an SMSF

It must be remembered at all times that anyone who holds property in an SMSF structure is obliged to comply with the Superannuation Industry (Supervision) Act and the superannuation industry regulations.

If the SMSF does comply, the applicable tax rate in the accumulation phase is 15 per cent. Exceptions may apply, such as 0 per cent on income and capital gains in the pension phase, with superannuation and death benefits receiving concessional tax treatment. If your SMSF fails to comply – and bear in mind ignorance is no defence – then the tax rate is 46.5 per cent. Asset protection may be another consideration.

There are many disadvantages to holding a property in an SMSF. One important reason is the fact that investment earnings may not be accessed by the members until they have established a condition of release or retirement as provided under the sole purpose test. The biggest drawback I see is that you cannot access the equity in one property to use toward another property — it is permanently trapped until the property is sold.
General expenses include accounting fees, audit fees, actuarial cost and compliance costs. Property expenses include real estate agent fees, depreciation, council and water rates, building write-off and interest expenses.

Sole purpose test

The SMSF's sole purpose is to provide retirement benefits to members. Trustees must consider whether purchasing property within their SMSF will satisfy the sole purpose test. One of the main issues that an SMSF auditor would look at when he or she audits a superannuation fund is whether transactions satisfy the sole purpose test. This may be breached if monies are used for some form of personal enjoyment.

Investment strategy trustees of an SMSF are required to prepare an investment strategy at the beginning of each financial year to determine the investment risks of each asset class and the ability to meet the member’s current entitlements. The trustees must consider whether the acquisition and subsequent use of a property and the percentage of the fund’s assets would incorporate the property within its investment strategy.

SMSFs and borrowing

An SMSF is unable to purchase property from a related party of the fund, unless it is funded by current members' benefits. However, an SMSF is permitted to acquire property from a related party where the property is a real business property (commercial property or business purposes.)

An SMSF may be able to acquire a property if the property is completed, or ‘off the plan’. Improvements being made to the purchased property would be a breach. The SMSF trust deed must allow the fund to borrow. Bear in mind that one of the mortgage insurers and some lenders are not comfortable with you purchasing a property being sold by a developer. The timing and creation of the bare trust and the purchase of the property is so important that documentation needs to be signed in the right order.

A loan under an SMSF is a non-recourse loan: trustees and members setting up this structure need to understand a non-recourse loan has restrictions in regards to other loans. If an ASIC-registered auditor finds problems with an SMSF structure, the auditor will have no choice but to issue a contravention report to the ATO. The maximum loan against a property within a bare trust in the SMSF is 80 per cent; you can refinance dollar for dollar.

Borrowing to purchase property within an SMSF is all about cash flow. Some considerations to bear in mind may be:

• Sufficient cash funding to service the loan on the property

• Sufficient cash reserves to make repayments on the loan in case rental income is lost

• Trustees of the fund having adequate risk insurance, including income protection, to ensure that a superannuation contribution guarantee benefit is included

• Many lenders have ceased lending on new properties and will only lend on second-hand stock. Forget about it being one or two years old as this may not change the fact it is still owned by the developer. Being sold via a real estate agent makes no difference

• Many lenders require a minimum of 10 per cent buffer in the fund and a minimum $150,000 to $250,000 in the fund

NOTE: This is general information only and is not to be construed as general or specific advice. Readers must seek professional advice before doing anything.

The pros and cons of SMSF investing
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