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Buying Property using your SMSF – What you should know

By Ershad Ullah September 23, 2022 | Tags:

Self-Managed Superannuation Funds’ (SMSFs) can be a tax-effective and efficient way of saving for your retirement. One increasing trend is to use your SMSF as a vehicle with which to buy property. This could be a positive financial move if it is appropriate for your circumstances and the fund is properly set up and managed.

Prior to 2007, SMSFs were not allowed to borrow for investment purposes, which meant that property investment wasn’t an option for most fund members. It is now possible for SMSFs to borrow funds under some clearly defined conditions. Property investing within your superannuation fund is certainly not an option for everyone and this should only be considered as one option in light of your overall situation and specific goals and objectives.

There are many factors that you to consider when undertaking this investment strategy. We have put together some of the critical issues that you need to consider.

What you Can and Cannot Do with Property in an SMSF

An SMSF is permitted to borrow money to acquire any asset which an SMSF is permitted by law to acquire directly. All borrowing activity must meet the following criteria:

  • Funds can only be borrowed to acquire a single asset
  • The asset should be held in trust with the SMSF holding a ‘beneficial interest’ in it
  • The SMSF should have the right to acquire direct legal ownership
  • in the case of loan default, a lender should only have rights over the original asset and not over the rest of the assets of the SMSF. (This is often referred to as ‘limited recourse’).

What types of property transactions are permitted

An SMSF can purchase an investment property and rent it out to tenants who are NOT fund members or relatives.

  • The fund can purchase commercial property – a business (including from a member or related party of the fund). This will allow the fund to lease commercial property to a member or related party of the fund so long as the arrangement is on the same terms if the arrangement was on a non-arms-length or commercial basis
  • Sell a residential investment property or commercial property to a member or related party of the SMSF, so long as this is on terms like dealing with someone on an arms-length basis.

What types of property transactions are not permitted

An SMSF cannot acquire a residential property already owned by a member or related party of the fund to the SMSF or rent a residential property owned by the SMSF to a member or related party of the fund. It cannot purchase a holiday home that is used for private purposes by members or their family, even if just one weekend in the year.

SMSF loans – How to arrange finance

Loans used to buy property within an SMSF are significantly different from mainstream mortgage products. SMSF loans must fulfil strict ‘limited recourse’ criteria. Limited Recourse Borrowing Arrangements (LRBAs) typically stipulate that the recourse of the lender will be limited to the fund asset that is being financed (including rights to income generated by the asset).

When you apply for SMSF loans there is an increased amount of paperwork as banks or lenders are more stringent in following due diligence procedures in order to minimise their exposure to excessive risk. You need to be prepared by carefully studying lender requirements and ensuring that all necessary documents are provided at the correct stages will facilitate the process of obtaining funding.

Most lenders require a personal guarantee from the fund member(s) which means the lender has a right to call on the personal guarantor for any shortfall after the disposal of the original asset acquired by the SMSF. Once the finance is in place the mortgage can be managed more or less in the same way as a ‘normal’ mortgage, dependent upon the loan features offered by the specific lender.

What do Lenders look for?

Create a table (coloured text box) with the following points under the heading

  • Compliance with superannuation laws and ASIC rules (if a corporate trustee).
  • Some lenders may only provide finance to SMSFs that have a corporate trustee.
  • Loans for construction, refurbishment or vacant land are typically not available.
  • Most lenders require an LVR of up to 70%.
  • Frequency of contributions to the fund
  • Expected rental income from the property.
  • Some lenders require clear written evidence that outside financial advice was sought before they will begin to process the loan application.
  • Lenders require evidence of existing insurance or may even require funds to take out specific policies aimed at the SMSFs holding property.

Who should you contact when considering an SMSF property investment?

The financial arrangements for buying property in an SMSF are a great deal more complex than would be the case with ‘normal’ property investment. There are several institutions and professionals involved in the process of purchasing a property within an SMSF, including:

  • the fund’s financial adviser and accountant
  • a real estate agent
  • the vendor and their solicitor
  • the fund’s legal adviser
  • a conveyancing solicitor
  • the lender and their solicitor
  • a finance broker
  • the Office of State Revenue

A significant proportion of mistakes made by SMSFs have to do with the blurring of lines between fund members and related parties. Three rules that are commonly breached are listed below:

  1. SMSFs are prohibited from making loans to or providing any type of financial assistance to members or their associates
  2. SMSFs are prohibited from holding in-house assets totalling more than 5% of the total value of the fund. In-house assets are defined as investments, loans or lease arrangements in which members or related parties have a significant stake
  3. SMSFs cannot acquire assets from fund members or other related parties to the fund except in the case of specified exemptions to this rule (listed securities, business real property and in-house assets that do not exceed 5% of the total market value of the fund).

Buying property within an SMSF can be quite complex (although certainly not impossibly difficult!). The ability to buy property in this way is also a fairly recent development. This means that many people you will deal with during such a transaction may not be sure of the right procedures, protocols and strategies for successful completion.

It would therefore be beneficial to consult with a professional adviser who does know what they are talking about when it comes to SMSF property investment. Getting such an expert on the side might seem like an expensive proposition at first, but you will almost certainly find that the time and money that you will save in the process will make it more than worth your while. If you are considering this investment strategy, please contact our office for assistance.

We offer a 15-minute free consultation to discuss your tax, property investment and business needs. Book your complimentary consultation now.
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