The Lowdown On Buying Property In Your SMSF
In my office, if we decide to embark on the SMSF journey, the first step is to make the client promise that they will not whinge about any part of the process for at least 6 months! It usually takes that long to bed it down and get them comfortable with the routine.
Borrowing to buy a property in a SMSF just makes the process that much more arduous. In fact, the very first step should be to find the bank you want to deal with.
To borrow to buy a property in a SMSF you need to have a bare trust to hold the property separate from the other SMSF assets. This is sometimes called the security trust. You will need to have this set up before you can sign a contract to buy the property and of course, you need to have the SMSF set up before this. Some banks want you to use their bare trust deed, some will charge you to have their solicitors review your bare trust deed if you have your own. The firms that prepare bare trust deeds do their best to make sure their deeds are acceptable to all banks. Banks change their policies on a whim and you don’t want to risk them charging you to review your deed so it is simpler to just choose your bank first and buy their approved deed.
So, what is important when choosing a bank? You want one that will allow you to have an offset account. One of the drawbacks of investing through superannuation is that you cannot borrow against the increased equity in your property to finance a deposit for the next one and the banks are very particular about sound deposits when it comes to SMSF lending. The best you can expect is 20%. This means you will probably have to save for a few years to buy your next property. In the mean-time, you want to get the best return you can on this cash and that is probably going to be through an offset account. If you instead pay down the loan you will not be allowed to redraw for the deposit, that is one of the quirks about SMSFs.
The next important factor in choosing a bank is the interest rate. SMSF loans are more expensive than other loans and this extra cost is a big factor in deciding whether a SMSF is the way to go. Also, expect quite a few thousand dollars in set up costs. Part of the reason there is much whinging along the way unless the ground rules are set from the start. But the biggest factor in the whinging is the sheer time and complication involved. From getting your employer onboard, dancing through the bank's hoops and keeping the seller happy.
So why would you go through all this? Well, the tax advantages are huge. Only 10% CGT at worse case scenario, that is if you sell before you retire and reach 60 years of age. If you sell in retirement phase the CGT is zero, even for the gain before retirement. Note to intending property moguls: you are limited in the value of assets you can hold in retirement phase but obviously, that would be the properties with the largest capital gain that you intend to realise.
The maximum tax you will pay on the fund's earnings is 15% and zero in retirement phase. If you haven’t tried to avoid your creditors, by making extra superannuation contributions, the bankruptcy trustee can’t touch your superannuation. Its just about everything on your wish list and it is not bad on estate planning either but that is another story.
If the property is negatively geared the tax outcome, assuming you are not fully utilising your superannuation contributions cap is very similar to owning a property in your own name. This is best explained by way of an example. Assume you have a rental property that is making a $10,000 loss and your taxable income is $100,000 a year.
Hold Property in SMSF Hold Property in your Own Name
Taxable Income $100,000 Taxable Income $100,000
Less Superannuation Contribution 10,000 Less Rental Property Loss 10,000
Net Taxable Income $90,000 Net Taxable Income $90,000
It is simply a question of whether you claim a tax deduction for the loss on the property or a superannuation contribution, providing you can keep all your concessional contributions (those either you or your employer claim a tax deduction for) under $25,000. By the way, contributions tax is a misnomer. The tax is not on the contributions but on the profit of the SMSF so if there is a $10,000 loss, from the property, in the SMSF to offset your $10,000 contribution, no contribution tax is paid.
If you are relying on your employer’s superannuation guarantee contribution to offset the loss on the rental property it is important that your employer pay that contribution into your SMSF with no detour via the fund they normally contribute to, as the contribution will be taxed or offset against the losses of the first superannuation fund it hits.
So if this hasn’t put you off, next week we will go through the questions that need to be asked right at the start to decide whether a SMSF is suitable for you.
* Please note this post does not constitute financial advice and does not take into consideration your specific situation. Please seek specific advice before acting.