Purchasing Residential or Commercial Property in your Self-Managed Superannuation Fund (SMSF)

Introduction

The purpose of superannuation is to provide retirement savings and income in your retirement years. Your employer or business will contribute funds into your superannuation fund to accumulate and grow over your working life. These funds will be invested in assets such as stocks, bonds and real estate.

Many investors prefer real estate over other investments due to the steady level of rental income received and perceived risk which can be comforting in retirement years, this makes property a popular asset class in super funds.

Purchasing an investment property within your SMSF allows you to purchase property with pre-tax dollars at 15%, not post tax dollars which could be as much as 47% which can not be understated.

A major tax advantage is you pay only 10% capital gains tax in accumulation phase to 0% tax on capital gains in pension phase.

Any rental income generated in the SMSF will be taxed at 15% concessional rates whilst in accumulation phase. Once you commence a pension, the incomes and gains will become tax-free in the fund provided that the fund balance is under the transfer balance cap $1.7 million as at 1 July 2021 ($1.9 million from 1 July 2023.)

If you are a property investor or business owner, you could benefit from this strategy by purchasing property through your SMSF and renting your business premises from it.

It is understandable why property in SMSFs is gaining popularity.

Investing in residential property

Residential properties purchased through a SMSF cannot be used as a residence by you, any other trustee, or anyone related to the trustees, regardless of how distant the relationship may be.

Additionally, these properties cannot be rented out by you, any other trustee, or anyone related to the trustees. This means that buying a holiday home in your SMSF and using it for personal use during the summer is not permitted.

It is important to note that the rules governing the ownership of residential property in an SMSF are stringent and clearly specify that the property cannot be rented or occupied by you, any other trustee, or any individual related to the trustees, regardless of their relationship to the fund.

Furthermore, it is important to be aware that you cannot transfer an existing residential investment property you own into an SMSF, whether by having the fund purchase it at market value or contributing to it within the contribution caps allowed.

Investing in commercial property

Investing in commercial premises through a SMSF offers certain advantages compared to residential properties.

Acquiring commercial properties within a SMSF is not limited to business owners alone but is open to all SMSF trustees. To invest in a commercial property through an SMSF, the fund may apply for a specialised SMSF loan. It's important to note that the criteria for such loans are stricter compared to traditional lending.

Numerous small business owners leverage their SMSF to purchase business premises and subsequently pay rent directly to the SMSF. It is crucial to ensure that this arrangement is handled correctly, with the rent paid at the market rate without any discounts, and in a timely manner, and in full, on each due date.

Additionally, it is essential to ensure that the investment in the SMSF aligns with the primary objective of providing retirement benefits for its members, as mandated by the sole purpose test, which is the overarching concept guiding SMSF investments.

Purchase options

A common question we often get asked: "Can you buy property with a SMSF?" and the answer is: an SMSF is the only way you can use your superannuation benefits to directly purchase property. As a business owner, you may have heard of the benefits of using an SMSF to own business real property, which you can then lease to your business.

You can either purchase the property from an unrelated party or transfer/sell property you already own personally to an SMSF, so long as it satisfies certain criteria known as 'business real property' conditions. What is business real property? It is simply land and buildings used wholly and exclusively by your business.

There's a bit to understand so let’s take you through the different ways you can use your SMSF to buy commercial property.

Advantages of buying property through your SMSF

• Freedom to decide how and where to invest your superannuation funds
  

• Superannuation income is taxed at 15% while you’re still working and at a rate as low as 0% when you’ve satisfied special conditions in retirement age. The concessional tax rates apply to both the rental income as well as any capital gains resulting from the sale of the property
  

• Capital gains tax on assets held more than 12 months is just 10%
  

• Earnings (including any capital gains) in the pension phase are not taxable (subject to the fund balance being under $1.7 million as at 1 July 2021 ($1.9 million as at 1 July 2023) or subsequent date that the transfer balance account is created
  

• Renting your business premises from your superannuation means you are paying off your own assets as opposed to paying off someone else’s investment
  

• Increased asset protection as your business and SMSF are separate entities
  

• Holding your business premises within an SMSF can provide asset protection against any future claims or liabilities that could result from operating your business. That means if your business is having difficulty, your property is safe
  

• As the property is held in your SMSF, you can guarantee and secure your business’s tenancy for the longer term
  

• Deductible life insurance premiums
  

• Deductions for rent paid to the SMSF in the higher taxed business entity
  

• In South Australia, commercial property is exempt from stamp duty

Let’s look at some of the common options available for owning commercial property in your SMSF.

Option 1 – Your SMSF Acquires Commercial Property via a Cash Purchase (Outright)

If you have enough cash available, the SMSF could purchase the property outright. This is the simplest form of ownership. The SMSF could purchase the property from either an unrelated third party or it could also purchase a property you currently own so long as it satisfies the business real property conditions.

Your business will need to pay market-rate rent to your SMSF and all expenses must be paid from the fund. A lease agreement should be drawn up, which will contain the details of the arrangement. It’s important to note that the property must always remain unencumbered.

Option 2 – Your SMSF Acquires Commercial Property from You via an In-Specie Transfer

If you currently own business real property you could transfer this property as a contribution to your SMSF. Careful planning is needed for this option to ensure you don’t breach the superannuation contribution caps and you may need to consider any capital gains that could arise from this transfer.

Just as with option one, to satisfy the superannuation rules the property can’t be encumbered, your business will need to pay market-rate rent to the SMSF and the SMSF will need to pay for any property expenses.

Option 3 – Your SMSF Acquires Commercial Property Indirectly via a Related Non-Geared Unit Trust

With this option, a unit trust is set up and the SMSF invests cash into the unit trust in return for a percentage ownership. The other units can be purchased by you or any other related party. For example, you want to purchase an $800,000 commercial property. A unit trust is set up and your SMSF buys 50% of the units ($400K) and you personally purchase the other 50% ($400K). The property is owned by the unit trust. Both you and the SMSF indirectly hold the property via your 50/50 ownership of the unit trust shares.

Your business will pay rent to the unit trust and the unit trust will distribute the net rent (post expenses) proportionally as per ownership to you and your SMSF.

It’s important to note the property can’t be geared in this structure. Additionally, rent must be at market rates and all expenses need to be paid by the unit trust.

Option 4 – Your SMSF Acquires Commercial Property as Tenants in Common

Similarly to option three, you‘re able to purchase a property as tenants in common with your SMSF. For example, your fund could purchase 50% of the property using the fund’s cash and you or another party could purchase the other 50% with your own money.

It’s important to note that all income and expenses need to be split as per the proportionate ownership on the title, and again, the property must remain unencumbered.

Option 5 – Your SMSF Acquires Commercial Property via a Limited Recourse Borrowing Arrangement (LRBA)

Where your superannuation benefits aren’t enough to purchase the property, your SMSF has the option to borrow money to purchase the property via an LRBA. These loans require an additional structure to be set up as the property must be held in a bare trust while there is a debt attached to it. One of the benefits is that the lender only has limited recourse to the property and no other SMSF assets.

If you’re thinking about going down this path, you should consider:

1. Speaking to a broker or lender who specialises in SMSF lending to check if your SMSF will be able to meet the lenders servicing requirements.
   

2. Getting a good understanding of the rules surrounding the restrictions of owning property via an LRBA

This option is far more complex than the others, so we recommend careful planning before going down this path and seeking appropriate financial advice.

As with all the different options available, the SMSF must comply with the superannuation rules at all times.

Renovations

Minor repairs and maintenance to the property can be funded using borrowed monies within the SMSF. However, if you plan to make significant improvements or renovations to the property, it must be financed using the cash already available within the super fund and not through loans or borrowed funds.

It's important to note that significant alterations to the original asset purchased under the limited recourse borrowing arrangement are not allowed. If renovations substantially change the asset, a new limited recourse borrowing arrangement will be required.

Single acquirable asset

The concept of 'a single acquirable asset' is crucial when dealing with a limited recourse borrowing arrangement (LRBA) within an SMSF. Essentially, if the property consists of multiple titles, each title will necessitate its own bare trust, trustee, and LRBA.

The Australian Taxation Office (ATO) has provided clarifications on specific scenarios where it is permissible to have only one LRBA, as well as situations where multiple LRBAs would be required

Single LRBA situations

• House and land package, or completed ‘off the plan’ property

• Apartment with a separate parking space

• Option (only) to purchase a house

• Factory that runs over multiple titles
  

Multiple LRBA situations

• Farmland featuring multiple titles

• Fully furnished serviced apartment, as the furniture is considered a separate asset to the apartment

• The seller may be selling two titles together, despite the fact they can sell them separately
  

Tax consequences

When purchasing a property through a SMSF, it is important to note that the fund pays 15% tax on rental income generated from the property whilst in accumulation phase. If the property is held for longer than 12 months, the fund may be eligible for a one third discount on any capital gains made upon sale, resulting in a reduced capital gains tax liability of 10% whilst in accumulation phase.

In case the property is acquired through a loan, it's important to note that the interest payments can be claimed as tax deductions by the SMSF. Moreover, if the property expenses exceed the rental income, resulting in a taxable loss, such losses can be carried forward to offset against future taxable income.

Additionally, once the trustees of the SMSF start receiving a pension during retirement, any rental income or capital gains generated within the fund will be 100% tax-free.

It's also worth noting that if a loss is incurred on the property, the tax losses cannot be offset against personal taxable income outside the SMSF.

Compliance

If the commercial property held by the SMSF generates a gross rental income exceeding $75,000 per annum, the fund is required to register for Goods and Services Tax (GST). Once registered, the SMSF becomes eligible to claim 100% of the GST on any expenses related to the commercial property.

SMSFs are required to value all of their assets at their market value, using objective and verifiable data. If the SMSF holds commercial property, an independent valuation needs to be obtained from a qualified real estate agent or registered valuer every 3 years.

Buying property in SMSFs works exceptionally work well for business owners, farmers that purchase farmland, professionals that purchase commercial office space and wholesalers purchasing warehouse space however this should be balanced with diversification and appropriate liquidity of the fund and circumstances outside the SMSF.

Your SMSF must be audited each financial year therefore it is imperative that everything is done to meet the rules and to avoid costly breaches.

Fees and costs

The purchase, ownership, and eventual sale of a property within an SMSF can entail significant fees and charges such as GST, discharge fees, establishment fees, settlement fees, documentation fees, valuation fees, legal fees, accounting fees, financial planning fees, rental agency management fees, stamp duty, council rates and taxes. These costs can impact your super balance, so it's crucial to ensure that the income within the super fund is sufficient to cover these expenses and allow for growth.

It's important to note that contributing personal funds towards the property purchase does not entitle you to withdraw the same amount from your super fund. Personal contributions are considered part of your super and cannot be accessed until you meet the preservation age requirements which is generally 60 years old and above.

Contact us

There are a lot of factors that need to be considered to determine if any of the options above suit your personal circumstances.

That’s where we come in. We will help you determine the most appropriate and simple approach to owning property in your SMSF.

If you’d like to find out if an SMSF is the right vehicle for purchasing residential or business premises within the superannuation environment. Please contact us to discuss further.

Contact Us

Disclaimer

No person should rely on the contents of this publication without first obtaining advice from a qualified professional person. This publication is for discussion and education purposes only and the editor is not responsible for the results of actions taken on the basis of information in this publication, nor for any error or omission from this publication. This editor expressly disclaims all and any liability to any person, including reader for any part of this publication.