This post is a guest post written by Noel May from Noel May and Associates, Chartered Accountants. You can learn more about Noel at www.noelmay.com.au
Buying a property in a Self Managed Super Fund (SMSF) is a smart business strategy which takes advantage of lower tax rates on income and capital gains. However while it’s ‘smart’, it’s not always the ‘best’ for everyone.
1. Negative Gearing
If you want to buy a property that generates positive cashflow and hold it for a while, then a SMSF may be perfect for you. But if you want to buy and renovate, or if the property is negatively geared then maybe there is a better structure for you.
One of the main attractions with having a SMSF as your investment vehicle is the low tax rate of 15% on the income of the fund, or 0% if you are over 60 years old, retired and drawing a pension from the fund. When you are facing personal rates of 31.5%, 38.5 or 46.5%, then 15% is attractive. The thought of paying only 10% on Capital Gains (or 0% if you’re that ‘over 60’ person) also looks pretty good to me.
But if the property within the SMSF is negatively geared, then the resulting loss from property rental is offset against other fund income, effectively giving you tax deductions at 15%. So you could be paying personal tax at 46.5% while your property investment makes losses which are trapped within the fund. The same property in your own hands would mean that the loss could be offset against your own income, effectively giving you a deduction at 46.5%.
2. Renovations
The ability for a SMSF to borrow to fund the purchase on an asset is governed by rules which are quite tight. One of those rules is that the funds borrowed cannot be used to improve the property, and only of recent times has there been a relaxation of the rules which now allows the funds to be applied to the maintenance of the property. So if your investment strategy is to buy, renovate and sell, then the SMSF option doesn’t allow the borrowings to be applied to renovations works.
(Kaz: Just to clarify for readers, you can renovate and improve property in your SMSF, using money from the SMSF, but not using borrowed money.)
3. Borrowing against Increased Equity
However, one of the biggest issues which is rarely discussed is the question of your ability to borrow against the increasing equity in your investment property to fund the next purchase. Assuming that you cashflow will support the increased borrowings, many investors rely on the capital growth in one property to help fund the borrowings for the next property. The ‘Limited Recourse Borrowing” rules in essence only allows the financier recourse to the single property over which they take a mortgage within the fund – no other superfund assets. The rules are quite specific about there being one borrowing for one purchase. Additional borrowings using that property as security are not allowed, even if you have paid down the equity on the original borrowing, you cannot re-borrow up to the value of the original loan. Borrowing against increasing equity is crucial to some investors’ acquisition strategy and is extremely important as it supports multiple purchases over time.
4. Lower LVR’s
The banks also don’t make it easy. Inside a SMSF the bank’s LVR’s are often 65%, maybe 70% as a maximum.
(Kaz: According to Jane Slack-Smith from Investors Choice Mortgages, we are more recently seeing some lending institutions offering 80% and there are frequent changes in the packages on offer to consumers as lenders try to grab the SMSF borrowing market)
Outside super, an investor can borrow 90% or more if all their ducks are in a row. The “Limited Recourse” nature of the loan within the super fund presents a greater risk to financiers and, to protect themselves, they lower the LVR so they have a bit of a cushion against the failure of the property to realise the loan value in a forced sale situation. This lower LVR results in the investor having to provide more of their own funds in order to purchase the property.
So while the low tax rate is very attractive to some investors, especially those approaching retirement, having your SMSF as your property investment vehicle is not the best option for everyone.
Need Advice?
If you need some advice on the suitability of different ownership structures that align with your particular investment strategy, then feel free to ring Noel May on 9585 7555 or email noel@noelmay.com.au. I’m sure we can help.