The Top 4 SMSF property investment mistakes
"If I was treasurer today, I would be looking very hard at the whole entitlement or availability of debt to SMSFs. They have gearing available to them and, of course, many of them are taking the option of buying residential property," he said.
The latest Australian Tax Office (ATO) SMSF statistics show that real residential property represents 3.5% of the value of all assets held in SMSFs. This level of investment has been consistent since 2009 with the bulk of properties worth between $200,000 and $1 million.
SMSF investment in commercial property is around 12%. However, what has changed is the number of investors with an average of 1,200 new investors using their SMSFs to purchase residential property each year. There has also been a substantial uptick in limited recourse borrowing arrangements, which have increased 1758% between June 2009 and June 2014.
For many SMSFs however, there are some very big risks if the borrowing arrangements and property purchases are not put in place correctly. If your SMSF breaches its compliance obligations, it is at risk of being deemed non-compliant and losing its concessional tax status and the trustees also risk being fined personally under the ATO's new penalty powers that came into effect on 1 July 2014.
So what are the biggest issues where SMSFs and property are concerned?
Liquidity, diversification and cash flow - The Superannuation Industry (Supervision) Act (SIS Act) requires trustees to take heed of these elements when making any investment. When an SMSF invests in real property, there is a risk that the trustees are putting all of the fund's 'investment eggs' in one basket and the rate of return will not be enough to meet the fund's obligations.
Funds in, or entering, pension phase need to meet the minimum pension drawdown requirements. The question is, will the rental yield meet the ongoing expenses of the fund including pension payments? Funds are required to increase the minimum pension drawdown over time: 4% at age 64, and 6% at age 75. That's an increase of 50% in draw down obligations. The question for investors then, is "Will rent increase by 50% to keep pace?"
Other questions that members should be asking include:
- What happens if a member wants a lump sum and not a pension? Where will the immediate cash come from?
- What happens when a member dies?
- How will the benefits be paid out from the fund? You can't sell one room of an investment property.
A common question that often comes up is "Can my SMSF buy a residential rental property, holiday home, or house from me or someone related to me?"
The answer is no, unless the property is business real property (a property used wholly and exclusively for business). And, in most cases, residential property will not meet the requirements to be business real property.
It's important to bear in mind that the penalty for breaching the related party investment rules is up to 12 months in jail.
If your SMSF has borrowed money to purchase a property, it cannot use any part of those borrowings to improve that property. Secondly, an SMSF cannot borrow money to repair an asset it already owns outright.
However, an SMSF can use its own money to improve or repair a property acquired with borrowings, as long as the improvements do not result in the asset becoming a different asset. For example, the trustees could not change a residential property into a childcare centre or turn a vacant block of land into an investment property.
The common problem areas for SMSF trustees are often simple things in the rush of the moment or simply poor structuring. The most obvious example is when a property is purchased by an SMSF but the contract is in the name of the individuals.
Sometimes people just get carried away and make the purchase without thinking through the details or where there is a related entity involved, like a unit trust, but the unit trust was not established before the property was purchased or the incorrect name is inserted on the contract or registered with the titles office.
Buying a property via your SMSF is decision that should be made with the above issues in mind. With good advice, you can avoid the mistakes we've outlined above as well as take advantage of the tax benefits available to you.
Your accountant is a good touchstone to make sure that your SMSF is taking on tax-smart debt and that the structure you use is appropriate for the other financial considerations for your future.
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Last updated November 2014. This article is provided for information purposes only and should not be used in place of advice from your accountant. Please contact us on 02 9957 4033 to discuss your specific circumstances.
This article is provided for information purposes only and correct at the time of publication. It should not be used in place of advice from your accountant. Please contact us on 02 9957 4033 to discuss your specific circumstances.