Self-managed superannuation funds (SMSFs) open up a whole new world of investment opportunities for your retirement savings, including direct property. But what if you simply don't have enough money in super to buy an asset outright?
Traditionally, you may have had to consider borrowing the balance yourself and then becoming joint owner of the investment with your super fund. Perhaps this would have been set up through a trust structure to give you flexibility later on.
However, changes to legislation now permit SMSFs to borrow money directly to help purchase investments such as direct property and shares. As with any SMSF investment, for this to be allowed, strict criteria must first be met.
Compliance is essential
The burgeoning growth in SMSFs combined with low interest rates and affordable property has encouraged more SMSF owners to invest in property. In 2012 the ATO issued an alert emphasising the need for compliance with the borrowing rules, specifically:
• Only commercial property or residential property used for investment purposes can be purchased and these transactions need to be made at “arm’s length” on a strictly commercial basis.
• Loans used for purchasing property need to be made on a non-recourse basis.
• The property title must be held in the name of the trustee of a Bare Trust, not the trustee of the SMSF or any member of the SMSF.
How it can work
We will use a case study to demonstrate how this works and, in this example, how borrowing within a SMSF can benefit small business owners.
Owners of CSJ Architects, Craig and Sarah James, currently lease their business premises. They want to buy the premises but with their current home mortgage, they don’t have the available money to do so.
Craig and Sarah’s SMSF has a balance of $430,000. They are interested in how they can use some of these savings to purchase the premises (valued at $500,000); eliminating future rental payments whilst building up a sound asset in their fund.
Can their SMSF borrow?
In this example, one of the benefits of investing through their SMSF is that the couple can use a portion of their existing superannuation balance as a deposit on the purchase of the business premises.
On these types of loans, banks are not likely to lend up to 80% or 90% of the property value as with normal investment loans. The deposit is more likely to be around 60% to 70%.
Here, the SMSF has borrowed $200,000 from the bank to make up the difference between the James’ deposit of $300,000 (60%) from their super fund and the purchase price of the premises. Over time, the SMSF will use rental income, plus super contributions received from Craig and Sarah, to repay the debt to the bank.
The remainder of their SMSF balance is invested across other asset classes to meet their fund investment strategy.
Is it better to borrow personally if you can?
Most property investors like the idea that any excess of expenses over the rent received can be deducted against other income. In other words, negative gearing can be a key factor in a wealth-building strategy using debt.
Within the SMSF environment, the tax benefits of negative gearing are not so obvious. The excess deductions cannot be claimed by the individual members, only by the fund itself. This outcome should be weighed against the advantages of SMSF borrowing, as well as having a sufficient deposit as noted above.
Like Craig and Sarah, the decision you make depends on your particular financial circumstances and arrangements. Don’t get caught up in all the marketing hype. Always consult a qualified SMSF adviser to ensure your fund has the most appropriate structure and investments for your retirement.
Call (02) 4926 2300 or email.
Sources:
www.ato.gov.au – Super – Self-Managed Super Funds
www.ato.gov.au "Taxpayer Alert TA2012/7"
If you wish to discuss borrowing within your SMSF or a have any questions in relation to this article, please do not hesitate to contact our expert team at Leenane Templeton.
