Thinking of setting up a Self Managed Super Fund (SMSF) to buy an investment property through your Super?
Many people like the idea of setting up a SMSF to buy an investment property. Far fewer people actually go ahead with the strategy.
In its latest statistical report on SMSFs*, the Australian Taxation Office calculated that only around 3.5% of Self Managed Super Fund assets (SMSFs) were invested in residential property in September 2013. While that accounts for around $18.6 billion, it also means that a far greater amount (around $512 billion) is invested in other assets such as shares (33%) and cash or term deposits (29%).
Less than 10% of the money invested in residential property came from borrowed money last year. Special loans for SMSFs primarily used for investing in residential property (called limited recourse borrowing arrangements) made up less than $3 billion, or about 0.6% of total assets held by SMSFs.
So what is the attraction of buying an investment property through Super? Why is so little invested this way, considering the amount of interest in it? Here’s a roundup of the pros and cons to help answer those questions.
What is the attraction?
- You like property as an investment – Australians love property investments, particularly residential property. Barbecues abound with stories of fortunes made and tips on the next hot suburb. There is good reason for this. Property has a place in a well-diversified portfolio and can offer good income and capital growth over the long term. Property is also attractive to people who like to be able to see and touch their investment and get involved in the management.
- Reduced or no Capital Gains Tax when you sell – Provided you keep your property investment in your SMSF until you are over 60 and retired, when you convert your SMSF into the Pension phase, you will pay no Capital Gains Tax if you decide to sell.
- Reduced or no income tax on rental income – You may also save tax on the rental income from the property. Provided you keep the property inside your SMSF, you will pay no tax on rental income in retirement and you will only pay 15% tax on the rental income while you are saving for retirement. That can be a big saving on your marginal tax rate.
- You own your business premises – According to ATO statistics*, around $62 billion or 12% of SMSF assets are invested in what they call “non-residential real property”, most commonly business owners who own their business premises through their SMSF. The great thing about this strategy is that you get rid of the tenants/landlord problems that plague commercial property and you may generate significant tax savings.
- You want to leverage your Super investment – If you decide to borrow money to buy your property inside Super, you increase your exposure to the investment, thereby magnifying the gains (and the losses) from the investment.
What you should think about?
- Are you better off buying the property outside Super? While the tax savings on capital gains and rental income are significant, the negative gearing benefits may also be significantly less. Plus, once you have the money invested in Super, it is locked away until you satisfy a condition of release, such as reaching age 60 and retiring.
- It can be complex and complicated. When you start up a SMSF, you take on a lot more responsibility. Investing in property adds another layer of complexity while you can add a further layer by borrowing money to buy the property. The additional complexity may lend itself to seeking professional advice from Accountants and Financial Planners. Which leads to the next point.
- It can be costly. Once you have paid for your Fund tax return, your annual audit your administration fees, it is unlikely you will be able to run a SMSF for less than $2,000 per year. On top of the usual costs of buying and selling property, such as stamp duty, real estate agent fees and conveyancing costs, by adding the property to the Fund, you are also likely to incur additional accounting fees. If you add a loan to this, you will also incur yet more fees in setting up and managing both the loan (called a limited recourse borrowing arrangement) and the additional Trust you require to hold the property (usually called a Bare Trust). As these fixed costs are high, the strategy is generally only suitable for people with at least $200,000 in Super (combined) and preferably substantially more.
- There are legal restrictions. There can be severe penalties for failing to stick to the rules which include:
- You can’t transfer a residential property you own currently into your SMSF
- You can’t live in the property and neither can any friends or family members
Buying property through your Super can be a great way to build up your retirement savings, but it pays to think long and hard about whether it is the right strategy for you before embarking on the strategy. As Australian Taxation Office Superannuation Assistant Commissioner Matthew Bambrick said recently at an industry SMSF conference^:
“Be cautious; watch out for property spruikers; take the time to make sure the property is the right investment for your Fund; make sure it fits with your existing investment strategy and if it doesn’t, take the time to revisit your investment strategy properly before deciding whether to buy the property. Don’t get caught up in the moment.”
If you have any queries relating to SMSFs, please contact your Adviser.
*Australian Taxation Office (ATO) “Self-Managed Super Fund statistical report – September 2013”
^5th Annual 2013 SISFA SMSF Forum, 17 October 2013