SMSF: Avoid bare trust mistakes
SMSF TAX FACTSHEET
Australians are increasingly setting up their SMSFs to hold investment properties under limited recourse borrowing arrangements ("LRBA").
Typically theses are set up using bare trusts and while that may be a preferred way to do so, there are some basic mistakes that can lead to consequences for the fund.
The key to avoiding the pitfalls? Get advice early, set up your SMSF properly and know your obligations for borrowing within an SMSF.
Bare trusts are often employed where it is necessary to conceal the true owner or purchaser of the property (e.g. shares, land, businesses, etc) which is to become the subject of the bare trust.
The bare trustee holds the legal ownership of the subject property for the express and absolute benefit of the true owner but the bare trustee has neither power or discretion as to the trust property and nor active role in administering the trust property.
SMSF regulations require that any property acquired with security (e.g. a mortgage) in place should be held in a holding trust, with the SMSF as the main beneficiary of the trust.
The SMSF will receive any rental income from tenants and pay interest to the lender. Once the loan is repaid, the legal ownership will be transferred to the trustee of the SMSF.
For property investment, the bare trust is simply the registered holder of the property until the loan is repaid. Typically, a bare trust is set up for each title on the property you intend to use for investment purposes and which has security against it from a lender.
While on the surface of it, a bare trust looks straightforward, there are often mistakes made in the set up and operation of a bare trust, particularly where there is a Limited Recourse Borrowing Arrangement in place.
We've outlined the key ones below that you should seek advice on before embarking on adding property to your SMSF:
Getting advice too late: Many people buying property for their SMSF often buy first and seek advice later. The downside is that they often do not understand the rules and requirements of owning property within an SMSF, which can create problems and costs (e.g. stamp duty) when it comes to selling the property or managing income, expenses and other SMSF compliance issues down the track.
Individual or corporate trustee: Our recent factsheet on the type of trustee required for your SMSF outlines the pros and cons of each type of trustee. Getting this right early ensures you can protect your investments properly from the outset.
Borrowing with little or no deposit: Borrowing to fund a property within your SMSF requires that you set up a formal arrangement for any security on the property.
Equally while many people may understand the concept of negative gearing, many don't understand that it doesn't work effectively in a low tax environment such as superannuation.
Property title: Investment properties purchased under a LRBA usually require separate titles for each property or title if they have the potential to be sold separately e.g. if an apartment and car space are on separate titles.
Use borrowings properly: Often trustees don't understand that borrowings in an SMSF can't be used in the same way finance can be used personally or in a family trust.
Trustees must understand that any borrowings must be used for purchasing a new property, not renovating properties in their super funds. Properties held in LBRA can not be significantly changed nor can the cost of doing so be used as a tax deduction.
Income, expenses & deductions: The bare trustee should hold the title of the property and nothing else; any rental income, GST payments, land tax and other costs are made and received by the fund trustee, thus there is no requirement for separate bank accounts for the bare trust. All expenses and deductions claimed for the investment property should be included as part of the SMSF's annual tax return, rather than submitting a return for the bare trust.
A key advantage of the bare trust is that it is not a reportable entity and does not require an ABN or TFN.
Separate the lender from the bare trustee: It's not advisable that the lender act as the bare trustee in a bare trust for several reasons.
The main one is that there is the potential for conflict between the rights over the property and the obligations a bare trustee has to report appropriately.
Establishing your SMSF with the right structure for your circumstances is not necessarily straightforward and talking to your accountant about your intentions is a good start to getting it right.
Contact us on 02 9957 4033 for more information.
Last updated October 2014. 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.