Recently we interviewed Noel May from Noel May and Associates all about buying property in a Self Managed Super Fund. That episode of Everyday Property Investing sparked a lot of interest from our listeners and also a lot of questions.
It was a great interview where we covered a lot of the basics of SMSFs and investing in property through your SMSF, you can check out the SMSF episode here.
The questions we had from our audience were fantastic and we thought it would be a great idea to share those questions and answers with everyone here on the website. A big thank you to Noel May for taking the time to answer some of these questions and to provide us with further information.
Please remember that your personal financial circumstances will determine what is right for you. You should speak with a qualified accountant and/or financial advisor to discuss your own personal circumstances. The responses provided here are an attempt to assist you understand some of the issues and rules – but these responses are not based on your specific circumstances!
Can you lend money to your SMSF?
Short answer, “Yes”.
Self Managed Superannuation Funds (SMSF) have the ability to borrow funds on “Limited Recourse Borrowing Arrangements” from financiers. There is nothing to say that you cannot be the financier.
If you have real estate or other assets in your own name, you may be able to use them it as security for a loan from a bank, which you can then on-lend to your SMSF.
But why would you do that?
There are a few reasons:
Most SMSF’s can borrow money from a bank but it must be on a limited recourse basis, which means that the bank’s security is limited to a charge over the asset acquired with the loan funds. The bank does not have any recourse to any other asset owned by the fund. Because of this limitation, the banks move to protect themselves by:
- Lowering the LVR on the loan (often only 65% of the property valuation) creating a bigger buffer should they ever need to sell the property in a forced sale situation,
- Charging higher interest to compensate them for the greater risk, and
- They often require a guarantee from the member or they take a charge over the private assets of the member.
Borrowing personally and on-lending to the SMSF has advantages in 2 areas:
- Interest – The loan from the bank will have a lower interest rate when lent to you, the member, than it would if it were lent to the SMSF, due to the SMSF loan being a Limited Recourse Borrowing.
- 100% borrowing – You can often fund 100% of the purchase price of the target property by taking the 65% LVR loan within the SMSF and making up the other 35% from a borrowing that you make personally using other assets that you can pledge as security.
What rate of interest can I charge the SMSF?
All dealings between a member and the SMSF must be “at arm’s length” and on a totally commercial basis. You could command a premium interest rate on the limited recourse loan that you make to your fund because of the security limitation; however, you are better to look at the benchmark rates charged by the major banks for SMSF loans and use those rates.
Logically, the limited recourse nature of the loan that you’ll be making to the fund is unlikely to command a rate lower than your borrowing rate. The arrangement must be commercial if you want to successfully claim the interest costs as a tax deduction. A situation where you borrow at one rate and lend out at a lower rate is not commercial.
How formal do we have to be?
The loan has to be a legitimate borrowing and subject to the same level of documentation as one would expect with an arm’s length loan. Formal documents, mortgage documents, regular payments of interest and possibly principal, all need to be in place. This financing arrangement is essentially just like a normal loan between a financier and the SMSF, except that you are the financier.
Borrowing against a property to purchase another
QUESTION: I understand that within the SMSF, the Custodian trust / limited recourse loan / ‘bubble’ set up for each individual property makes it a stand-alone entity within the fund… and therefore does not allow me to directly use the additional equity of my initial property as security for a second property. However, in the event that the initial property were to increase in value, would it be possible to refinance that first property (back up towards 65% LVR), thereby accessing that cash to use as an deposit for the second property? Otherwise, it could feel like an eternity in the time taken to pruchase the first and second property.
Short answer is NO.
Investors should look at it as if they are only allowed to borrow once. You can’t take a second borrowing secured by the increased equity in the existing property, whether that be a totally separate borrowing or just a small borrowing to bring you up to the previous LVR that you have since paid down.
This is clearly a negative with using SMSF’s as your investment vehicle if you are planning to rely on the increased equity in the first property to fund deposits on additional purchases.
You may be better to sell the first property, make the gain, pay the CGT and then buy the second – but that’s just a piece of arithmetic to see if it is worthwhile selling.
Will lenders really only provide 65% LVR for a limited recourse loan to a SMSF, I’ve heard some will provide up to 80%?
Well, actually, this came to us more as a negative comment than a question, but it sounds so much more pleasant when I rephrased it!!
In typical Accountant fashion, Noel and I discussed a conservative LVR of about 65%, which is a very real likelihood with many lenders. We were, however, discussing things in a general fashion. You may find that some lending institutions offer a higher LVR.
I asked our good friend Jane Slack-Smith from Investors Choice Mortgages if an 80% LVR was realistic to achieve and she responded that yes, you may be able to find a bank that will loan to a SMSF up to 80% LVR and she knew of a couple of offers that were in the market currently. Mortgage products, deals and packages change frequently, so it’s a good idea to check with your mortgage broker about what is on offer at the time when it’s relevant to you.
Your podcast mentions borrowing to develop property in a SMSF – but I thought that a SMSF cannot borrow to build – is this correct?
Once again, this came to us more as a negative comment than a question, but again, it sounds so much more pleasant this way, so I’ve rephrased it!!
When dealing with the tax office, who sets the rules in terms of the limited recourse borrowing arrangements, of course things are never simple and straight forward!
In very simplistic terms, at the time of writing this (and things do change) when using limited recourse borrowing arrangements in a self managed super fund, you can borrow money under the a set of specific conditions. Some of the key conditions are:
- You can borrow money for the acquisition of a single acquirable asset (or collection of identical assets that have the same market value and are treated as as single asset). This also means that expenses incurred in connection with the borrowing or acquisition (things like loan establishment fees, stamp duty) can be borrowed.
- You can borrow money for maintaining or repairing the acquirable asset
- You cannot borrow money for improving the asset
So this means that borrowing to buy a block of land in your SMSF build a couple of units on it is a no go.
You can, however, enter into a house and land package type arrangement or buy a strata titled unit off the plan where the contract includes the building of the property.
It’s all a bit convoluted and complex and I’d suggest you consult your accountant to discuss anything specific that you have planned or read the nitty gritty details on the ATO website before you go making a purchase!
Where do I find the nitty gritty, technical details of what I can and can’t do?
If you’re after a bit of ‘light reading’ – like I was for this article – then I will point you to a couple of places on the ATO website where the nitty gritty details are provided. Be warned though, the ATO website is like a circular reference in an Excel spreadsheet (oh my, I am such a geek!). Trust me, it’s pretty hard going to find what you want and then to get through this type of thing.
Definitely a conversation with your accountant would be more fun(?!?). In fact, I think whacking yourself across the head repeatedly with a large trout may be more fun than reading this stuff….hmm…yes, go see an accountant…
- ATO – Self Managed Super Funds
- ATO – Limited Recourse Borrowing Arrangement by Self Managed Super Funds – Questions and Answers
- ATO – Self Managed Super Funds Ruling 2012/1
In which circumstances would you find that a SMSF is NOT the best way to go?
If you have questions or need some advice on buying and borrowing in your SMSF to fund the purchase of a property, then feel free to ring Noel May on 9585 7555 or email firstname.lastname@example.org. I’m sure we can help.