SMSF TAX FACTSHEET
Do-it-yourself super via a Self-Managed Super Fund (SMSF) has proven to be popular in Australia, with more than $450 billion held in investments by more than half a million funds.
SMSFs are attractive for a range of reasons, but the primary reason is that SMSFs provide greater control over how assets are invested, the types of assets acquired by the fund, the ability to plan tax outcomes, and potentially reduce costs.
Recent changes to Section 67 of the Super Industry (Supervision) Act means that it's now easier for SMSFs to use gearing to fund their investments.
Inexperienced or unwary trustees are often tripped up by strict rules that govern how SMSFs use borrowing to fund asset investments.
Changes to super laws allow funds to borrow to invest provided they follow the legislation to the letter and that means:
- Assets must be held in trust until the fund pays the final installment on the loan.
- The borrowing arrangements are generally a 1-1 basis: a single gearing arrangement can only be used for a single asset (one type of shares) or collection of identical assets (for example a diversified equity fund).
- There is no recourse to utilise other SMSF assets in the event of a default on the loan.
The acid test should be whether borrowing is really in the interests of the SMSF's members - particularly if they are close to retirement.
Gearing is typically a longer-term strategy and borrowing to fund the purchase of an asset means that the term of the loan has to be considered against the likely capital gain over the same period.
Borrowing to fund the investment requires a solid strategy and structure to ensure that the cost of borrowing can be met, that the tax position of the members is optimal and that the asset itself doesn't tie up a significant portion of the fund for a period of time that doesn't match the retirement goals of the members.
The primary benefit of using a gearing strategy for your SMSF is that borrowing enables the SMSF to acquire assets it might not otherwise be able to afford to increase the holdings of the fund.
The main tax benefits of gearing include:
- The multiplier effect of geared assets - capital gains are multiplied if the asset rises in value whilst the earnings and capital gains are concessionally taxed within the fund.
- Concessional super contributions can be used to service the fund's loans
So what are the types of assets you can consider?
There are two asset groups that typically make up the bulk of SMSF funds - shares and property.
Shares generally can be acquired at considerably less cost than property however bring with them the inherent risk of volatility and magnified losses when attached to gearing.
While many SMSFs tend to acquire property as their main asset, there are also risks in having a significant portion of the fund's value tied up in a single, high-value asset.
Sample structure for property in an SMSF
Business owners, particularly self-employed business owners, often use their self-managed super to buy property for their business as it is one of the few assets that SMSFs are allowed to buy from their members and can yield some good tax benefits.
Holding business premises can generate rental income for members and that in turn can produce excellent tax benefits such as concessional tax paid on the rent. Often the rent is then used to pay down the loan.
The downside of this strategy is that if the business gets into financial trouble, it may not be able to pay the rent and the property itself may be difficult to rent to other tenants at an acceptable rent. If the members' business doesn't do well and capital gains aren't realise then the value of retirement savings could well be affected.
Sample structure for business assets in an SMSF
Although the opportunity to gear into property proved to be a major selling point for SMSF trustees, there are still a lot of traps in this area, for example:
- The trustees are permitted to use the borrowed funds to conduct repair upon purchase of the assets but not if the repairs constitute improvements. This comes down to the differences between repairs and improvements, which is not always clear cut.
- The trustees are allowed to borrow from a related party and take security over more exotic assets which the banks may not fund. However this does not work for in specie transfer of a property.
SMSF rules are complex so it's important to ensure that if you're considering gearing your investments that you get the right advice as to how it will affect your position tax-wise. Contact our team for more information on 02 9957 4033.
Download PDF Version: Gearing Your SMSF
Last updated July 2013. This factsheet is provided for information purposes only and is correct at the time of publishing. It should not be used in place of advice from your accountant. Please contact us on 02 9957 4033 to discuss your specific circumstances.