Real residential property makes up 3.5% of the value of all assets maintained in SMSF’s according to the latest SMSF figures from the Australian Taxation Office (ATO). This has been the level of investment since 2009, with a high proportion of properties valued between $200,000 and $1 million. Commercial property represents about 12% of SMSF investment. However, there has been a change in the number of investors, with an average 1,200 new investors utilising their SMSFs to buy residential property annually. And, the limited recourse borrowing arrangements have soared by 1758% between June 2009 and June 2014.
However, many SMSFs face some very massive risks if the borrowing arrangements and property purchases are not set up properly. If there is a breach in compliance requirements, your SMSF is in danger of being charged with non-compliance and may lose concessional tax status. In addition, the trustee may also be penalised under ATO’s new penalty authority that became effective on 1 July 2014.
Is Buying Property with your SMSF Right for you?
Liquidity, diversification and cash flow. Under the Superannuation Industry (Supervision) Act (SIS Act), trustees are required to watch out for these three elements when investing. For SMSF investment in real property, there may be issues if trustees place the fund’s entire “investment eggs” in one basket. If this is the case, the return will be inadequate to meet the fund’s commitments.
When in pension phase the fund has to meet the minimum requirements for pension drawdown. There is an issue of whether the rental yield can meet the fund’s current expenses including pension payments. Money is needed to raise the minimum pension drawdown through the years: 4% at age 64 and 6% at age 75. The number is up 50% in drawdown commitments. Will rent jump by 50% to keep up with payments.
However, what happens if a member prefers a lump sum over a pension? Where can the fund get the money? What happens upon the death of a member? How would the fund pay out the benefits? It would be a challenge as selling one part of the investment property is not permitted.
Can My Investment Property Be Purchased by my SMSF?
A typical question that is frequently asked is, can I use my SMSF to purchase a residential rental home, holiday home, or house from me or a relative of mine? The answer is you can’t, except if the property is a business real property, or a property utilised fully and solely for business. And, more often than not, a residential property will fail to meet the criteria to be a business real property. Don’t forget that the penalty for violating the related property investment law is imprisonment of a maximum of 12 months.
Upgrading a Property
If your SMSF used loaned money to acquire property, it is barred from using any portion of the loan to upgrade that property. In addition, an SMSF is not allowed to borrow money to fix a property that it owns.
But an SMSF can utilise its own funds to upgrade or fix a property bought with borrowings, provided the upgrades do not turn the property into a different property. For instance, a residential property cannot be converted into a children’s centre. Or, develop a vacant land into an investment property.
Consider a SMSF that takes out a loan to purchase a residential home on a big block of land ready for development. It is not legal for the fund to subdivide the lot and construct a new house as the borrowing policies do not allow a modification in the character of a property purchased using borrowed money pending the termination of the loan.
Committing Mistakes on Important Matters
SMSF Trustees often commit simple mistakes as a result of rushing the moment or just bad structuring.
Here’s the most noticeable example: putting the names of the members when a property is bought by the fund. There are times people get excited and proceed with the transaction without carefully considering the details. Or, when a related entity is involved, like a unit trust, but the unit trust was not created prior to the acquisition of the asset or the wrong name is typed into the contract or filed with the titles office.
Are you considering investing in a self-managed super fund (SMSF)? There are strict laws that govern the management of SMSF. PJS Accountants can help you determine if it is the right investment option for you. For enquiries about SMSF and how we can help you start a good investment strategy, contact PJS Accountants.