A Beginner’s Guide: Using a Self-Managed Super Fund (SMSF) to purchase your next property
Introduction
Using your superannuation fund to buy a property can be a potential option for your next purchase, but it also can be tricky to understand and navigate.
In this guide, we’ll navigate the basics of setting up and using an SMSF for property investment in Australia.
Section 1: The ABCs of Self-Managed Super Funds
1.1 What is an SMSF?
A Self-Managed Super Fund (SMSF) is a do-it-yourself superannuation fund that allows you to take control of your retirement savings.
Unlike traditional super funds, SMSFs give you the freedom to make investment decisions, including the option to invest in property.
SMSF comes with tax laws that you need to become familiar with. It’s essential to have a solid understanding of these rules and have your accountant or financial advisor guide you through the process of setting it up correctly.
1.2 Who Can Set Up an SMSF?
While SMSFs offer flexibility, they come with responsibilities. Generally, an SMSF is suitable for those seeking more hands-on control over their retirement savings. A small group of members, often family or friends, can jointly establish and run an SMSF.
A SMSF fund can have up to 6 members and can only be used to purchase an investment property – not a home to live in.
Your accountant and financial planner can set up the SMSF on your behalf.
Section 2: Setting Up Your SMSF
2.1 Legal Requirements and Compliance
To embark on your SMSF journey, you need to follow legal requirements and ensure compliance. This involves appointing trustees, creating a trust deed, and registering your fund with the Australian Taxation Office (ATO).
Seeking professional advice from an accountant during this setup phase is essential.
2.2 Contribution and Investment Strategy
Determine how much you’ll contribute to your SMSF and craft an investment strategy that aligns with your financial goals. This is a critical step as it shapes the growth and success of your fund over time.
Section 3: Investing in Property with Your SMSF
3.1 The Property Option
One of the unique advantages of an SMSF is the ability to invest in property. This can include residential or commercial property.
Pros of Owning a Property with an SMSF:
Building Wealth for Retirement: Buying property through your Self-Managed Super Fund (SMSF) can be a great way to grow your retirement savings over time.
Potential Tax Benefits: You might enjoy tax advantages, like lower tax rates on rental income and potential discounts on capital gains when you sell the property.
Diversification: Owning property adds diversity to your super investments, spreading out the risk and potentially increasing your overall returns.
Control Over Investments: With an SMSF, you have more say in your investment decisions, including choosing and managing your property.
Cons of Owning a Property with an SMSF:
Complexity and Rules: There are specific rules and regulations for owning property in an SMSF, and it can get a bit complex. It’s crucial to understand and follow these rules to stay compliant.
Costs and Fees: Setting up and maintaining an SMSF can involve extra costs, and property transactions may come with additional fees. It’s essential to factor in these expenses.
Liquidity Challenges: Property isn’t as easy to sell as other investments. If you need quick access to cash, selling property might take time, and it’s not always straightforward within an SMSF.
Market Risks: Like any investment, property values can go up or down. If the property market takes a dip, the value of your investment could decrease.
Remember, while owning property in an SMSF has its perks, it’s crucial to weigh the pros and cons carefully. Seeking advice from financial experts can help you make informed decisions that align with your financial goals and risk tolerance.
3.2 Funding Your Property Investment
Your SMSF can use existing funds or borrow to invest in property, a strategy known as Limited Recourse Borrowing Arrangements (LRBA).
Limited Recourse Borrowing Arrangements (LRBA) might sound like a bit of a mouthful, but let’s break it down simple terms.
Imagine you want to buy a property through your Self-Managed Super Fund (SMSF), but you don’t have enough money in the fund to pay for the whole thing. LRBA is like getting a loan, but with a safety net.
Here’s how it works: Your SMSF can borrow money to buy a property, and that property becomes the security for the loan. The cool part is that if things don’t go as planned and the SMSF can’t pay back the loan, the lender’s rights are limited only to the property. They can’t chase after the other assets in your super fund.
It’s kind of like having a safety rope when you’re climbing – you can reach for the stars, but if things get tricky, you’re securely tied to the ground.
3.3 What are the costs of owning a property in a SMSF?
Owning a property through your Self-Managed Super Fund (SMSF) in Australia can be a bit like maintaining a clubhouse—you’ve got to cover some costs. Here’s a breakdown:
Set-Up Costs: Think of this like getting your clubhouse keys. There are fees to set up your SMSF, including creating the necessary documents and registering it with the authorities.
Property Purchase Costs: When you buy a property, there are additional expenses such as legal fees, stamp duty, and maybe even lender fees if you’re borrowing money for the purchase.
Ongoing Administration Fees: Like a yearly clubhouse membership, there are ongoing fees to keep your SMSF up and running. This covers things like audits, tax returns, and making sure your SMSF is playing by the rules.
Professional Advice Fees: It’s like having expert advisors for your clubhouse. You might need to pay professionals like accountants or financial advisors for their guidance and expertise.
Property Maintenance Costs: Just like keeping the clubhouse in good shape, there are maintenance costs for your property. This includes things like repairs, insurance, and maybe property management fees if you’re renting it out.
Remember, while there are fees involved, having your SMSF and property can be a powerful way to grow your wealth. Make sure to budget for these costs and maybe even chat with financial experts to help you manage everything.
Section 4: Legalities and Compliance
4.1 Staying on the Right Side of the Law
Compliance is key to the success of your SMSF. Understand the legalities involved in property investment, including the sole-purpose test, and ensure that your actions align with the rules set out by the ATO.
4.2 What is the sole purpose test?
The Sole Purpose Test is like the guardian rule for your Self-Managed Super Fund (SMSF). In simple terms, it ensures that the main mission of your SMSF is to help you retire comfortably.
This means all the decisions and actions your SMSF takes should be geared towards providing benefits for your retirement, and not for anything else.
You can’t use the fund for personal gains or non-retirement purposes.
Regularly checking that your SMSF stays true to this mission and keeping good records of decisions are key. It’s like a GPS for your super savings, making sure they’re on the right path to secure your future.
4.3 – Self-managed super fund property rules
There are rules that are governed by the ATO around how you should run your SMSF.
- The property must meet the ‘sole purpose test’ of only providing retirement benefits to fund members.
- The property can’t be purchased from a related party of a member.
- The property can’t be lived in by a fund member, or any fund member related parties
- The property can’t be rented by a fund member or any fund members’ related parties.
If the SMS purchases a commercial property, it can potentially be leased to a fund member for their business. However, it needs to be leased at a fair market rate and follow specific rules.
See Australian Taxation Office website for more on SMSF rules.
Section 5: Tax Considerations
5.1 Tax Benefits of SMSF Property Investment
Owning a property through a Self-Managed Super Fund (SMSF) in Australia comes with some cool tax benefits.
First off, rental income from the property is usually taxed at a low rate of 15%, which can be a lot less than your personal income tax rate.
Plus, if you sell the property down the road and make a profit (called capital gains), there are potential discounts that could apply, making the tax you pay on that profit lower than usual.
Also, if you’re in pension phase and start drawing down income in retirement, that income can be tax-free. It’s like the government giving you a bit of a tax break to help grow your retirement savings through property.
Just keep in mind that tax rules can be a bit tricky, so it’s always smart to chat with a professional to make sure you’re getting all the benefits you’re entitled to!
Section 6: Risks and Mitigation Strategies
6.1 Navigating Risks in Property Investment
Risks associated with investing in property through a self managed fund (SMSF) include;
1. Higher expenses; SMSF property loans generally come with higher set up costs compared to standard home loans.
2. Cash flow considerations; It is important to ensure that your fund always has liquidity or cash flow to cover expenses. These may include loan repayments, insurance premiums, property related costs, like rates and management fees as potential retirement pension payments or lump sum withdrawals.
3. Loan repayment strategy; It is crucial to have a plan in place for repaying the loan in case of circumstances such as illness, disability, death of members or rental vacancies.
4. Difficulty in cancelling arrangements; If the documents and contracts related to your SMSF property loan are not properly set up undoing the arrangement can be challenging.
In some cases selling the property may be necessary resulting in losses for the SMSF.
5. Tax implications; It’s important to note that tax losses from the property cannot be offset against your income outside of the SMSF.
6. Restrictions on property alterations; Until the SMSF property loan is fully paid off making alterations that change the character of the property is not permitted.
Investors should carefully consider these risks before proceeding with an SMSF investment.
Section 7: Using the First Home Super Saver (FHHS) to purchase a property
What is the FHHS scheme?
FHSS is like a superhero cape for your savings. It helps you stash away money in your superannuation fund to use later when you’re ready to buy your first home. It’s the government’s way of giving you a little boost in your home-buying adventure.
This is a little bit different to purchasing a property through a SMSF.
First home buyers are allowed to use the funds within their superannuation account to purchase a property to live in, whereas a SMSF purchase can only be used as an investment.
This scheme helps first home buyers save for their deposit faster, because of the favourable tax concessions inside their super.
First home buyers eligible for the scheme can make voluntary concessional (before-tax) and non-concessional (after tax) contributions in their super fund to save for their first home of up to $15,000 per financial year.
They can then apply to release the contributed funds and any other earnings for their deposit.
A first home buyer can contribute up to $15,000 a year under the FHHS scheme to a maximum of $50,000.
The first $25,000 that goes into the account year is taxed at just 15%, not at the usual marginal rate.
First home buyers can start saving under the scheme by speaking to their employer and entering into a salary sacrifice agreement with their employer. Or alternatively, they can make voluntary personal super contributions.
Any compulsory contributions an employer makes, as well as voluntary contributions are counted towards the threshold.
In order to be eligible for the FHHS, first home buyers need to live in the property they’re intending on purchasing ‘as soon as practicable’. They also need to live in the property for at a period of at least 6 months within the first year of ownership.
Eligibility is assessed on a person-to-person basis. This means couples, siblings and friends can each access their own eligible FHHS contributions to purchase the same property.
Key Points:
Saving in Your Super: You can voluntarily put extra money into your super fund, up to certain limits, specifically for your first home.
Tax Breaks: Here’s the cool part – the money you put into your super for FHSS gets taxed at a lower rate. It’s like the government saying, “We want to help you save more!”
Withdrawal for Your First Home: When you’re ready to buy your first home, you can take out the money you saved through FHSS, along with some earnings. It’s like opening your treasure chest to get your well-deserved reward.
How to Use FHSS:
Check Your Eligibility: Make sure you meet the requirements. You’re usually eligible if you’re at least 18, haven’t owned property before, and intend to live in the home you’re buying.
You can check your eligibility here:
Start Saving: Put extra money into your super using the special FHSS contributions.
Apply to Withdraw: When you’re ready to start searching for your next property, apply to the Australian Taxation Office (ATO) to take out your FHSS savings.
Keep in Mind:
Limits: There are limits to how much you can save using FHSS, so it’s good to know the rules.
Timeline: There’s a timeline to follow, so plan ahead and start saving when you can.
Get Advice: If you’re unsure about anything, consider talking to a financial advisor. They’re like the guides in your home-buying adventure.
Conclusion
In summary, having a self-managed superannuation fund (SMSF) property in Australia requires careful planning and strategy.
The real estate market offers promising prospects for building long-term wealth, but it’s crucial to make wise choices, keep a close eye on monitoring your investment and comply with regulations to overcome the obstacles successfully.
By familiarising yourself with the rules of the game and seeking advice whenever necessary, you can take advantage of the perks that come with owning an SMSF property while effectively managing any associated risks.
Property-Buying Support
If you’re looking to purchase your next property within a SMSF structure or using the FHHS scheme then click the link below to book in a free chat with a buyer’s advocate.
We’ll look into your current situation and future needs. We’ll then walk you through our property-buying program or our buyer’s advocacy services only if we think we’re the right fit for you.
