Posted on April 29th, 2024

Using your SMSF to invest in property

It appears as though the self-managed superannuation fund (SMSF) revolution in Australia is now in full swing.

Currently, approximately 1.1 million Australians manage their own superannuation through SMSFs. According to Deloitte’s 2022 data, Australian males aged 45 to 49 typically have $224,200 in their super, while females of the same age range have an average of $146,400.

These SMSFs make up over 610,287 funds nationwide, holding around 25% of the total $3.5 trillion invested in superannuation. According to the Association of Superannuation Funds of Australia’s Retirement Standard, for a ‘comfortable’ retirement, a couple who own their own home will need an income of approximately $70,500 per year, while a single person will require an annual income exceeding $50,000.

With numbers like these, it’s clear that Australians are looking to self-managed superannuation funds (SMSFs) as a means of taking control of their financial future.

Since a rule change in 2007, SMSFs can now borrow money to invest in all types of real property, including residential property. This is good news for the growing number of Australians who want to use their superannuation to invest in property and secure for themselves an income stream that will last throughout their retirement years.

When you choose to invest in property through your SMSF, you gain the ability to control how your retirement funds are invested and ultimately create a path for long-term financial success.

But with great power comes great responsibility – or at least, careful consideration. Before rushing into buying an investment property through your SMSF, it’s important to understand the ins and outs of this type of investment, as well as the rules and regulations surrounding it.

Understanding the Rules and Regulations of SMSF Property Investment

Before diving into the world of SMSF property investment, it’s important to understand the rules and regulations that govern this type of investment. These include:

The sole purpose test: The primary purpose of an SMSF is to provide retirement benefits for its members. This means that any investments made through your SMSF must be solely for the purpose of generating retirement income. Property investments must also adhere to this rule and cannot be used for personal gain or benefit.
Borrowing restrictions: As mentioned, SMSFs are now allowed to borrow money to invest in property. However, there are strict guidelines around how this can be done. For instance, only certain types of borrowing structures are permitted, and the borrowed funds cannot be used for renovations or improvements to the property.
Acquisition from a related party: SMSFs are not allowed to acquire residential property from a related party, such as a family member. This means that you cannot purchase your own home through your SMSF, even if you plan on living in it during retirement.
Maintenance and upkeep: As the trustee of an SMSF, it is your responsibility to ensure that the property is maintained and all necessary repairs are made. This means you must have enough funds within your SMSF to cover these expenses, which can be challenging for many investors.
Tax implications: While SMSFs offer tax advantages, it’s important to understand the specific tax implications of investing in property through your fund. For instance, rental income from the property is taxed at the SMSFs tax rate, which may be lower than your personal tax rate. Capital gains made on the property will also be taxed at this rate when sold.

Why invest in property through an SMSF?

Diversification

Property can be a valuable addition to your investment portfolio, and investing through an SMSF allows you to diversify your assets. This can help mitigate risk and potentially increase your returns.

Control

As the trustee of an SMSF, you have complete control over how the property is managed and maintained. This allows you to make decisions based on your personal investment goals and preferences.

Tax advantages

As mentioned, SMSFs offer tax advantages that can benefit property investors. Here are some tax considerations for rental income in SMSFs:

Rental Income Tax: The rental income generated by the SMSF is subject to a 15% tax rate. Additionally, properties held for over 12 months receive a one-third discount on capital gains tax.
Loan Interest Deductions: Interest payments on SMSF property loans are tax-deductible. In cases where expenses exceed income, a taxable loss can be carried forward each year and offset against future taxable income.
Capital Gains Tax: When selling a property held for more than 12 months, a capital gains tax of 10% applies. However, if the SMSF trustee has entered the pension phase and the income falls within the transfer balance cap (currently $1.9m for the 2024 year), different rules may apply.

7 key considerations when buying property through an SMSF

If you are considering investing in property through an SMSF, it is important to keep the following key considerations in mind:

Legal structure and setup costs: Setting up an SMSF can involve legal and administrative fees, including setting up a trust deed and obtaining professional advice.
Borrowing restrictions: The use of borrowed funds to purchase property through an SMSF is subject to certain restrictions. For instance, you cannot use the full balance of your SMSF to buy an investment property. Additionally, restrictions on borrowing from related parties may also apply.
Sole purpose test: The property must primarily be for investment purposes and not for personal use or benefit. This includes ensuring the property is only rented out to unrelated tenants.
Cash flow management: As with any investment, it is important to carefully consider the cash flow implications and keep a suitable cash reserve for unexpected expenses.
Maintain Liquidity Buffer: SMSFs must keep a “liquidity buffer,” consisting of assets like cash and shares, equivalent to at least 10% of the proposed investment’s value. This helps ensure that the SMSF can meet its ongoing expenses and is not solely reliant on rental income from the investment property.
Legal Ownership Structure: Understand that the legal ownership of the purchased asset is held in trust, ensuring compliance with SMSF regulations.
No Direct Debt for Property Purchase: It’s crucial to note that purchasing a property using debt directly through the SMSF is not allowed. The borrowing must be done through the specified LRBA structure.

Summary

Using a self-managed superannuation fund (SMSF) to invest in property is a powerful step towards taking control of your retirement plans. As Australians increasingly explore the possibilities offered by SMSFs, the ability to borrow money for real property investment, including residential property, has opened new doors for securing a stable income stream throughout retirement.

While traditional asset classes, such as stocks and bonds, have long been the primary investment choices for SMSFs, the introduction of limited recourse borrowing arrangements (LRBAs) has allowed SMSFs to diversify their portfolios by investing in property. History shows that real estate investment only provides an opportunity for higher returns on investments than those typically seen in the stock market. but also offers a safeguard against market volatility.

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