It’s possible to use your super to invest in property by setting up a self-managed superannuation fund (SMSF). An SMSF is a type of trust fund used in Australia by people who want to manage their super on their own.
An SMSF differs from other types of super funds as the fund members are also its trustees. It means if you set up an SMSF, you’ll be both a member and a trustee.
As a trustee, you’re responsible for operating the fund and ensuring compliance with the various legal and regulatory requirements. The Australian Taxation Office (ATO) lays down strict conditions for setting up and managing an SMSF to prevent members from losing their retirement savings. Non-compliance with the laid down regulations can lead to penalties.
What you should know about buying property through an SMSF trust?
A self-managed super fund gives you more control over your retirement nest egg by allowing you to invest your super money yourself. You can choose from a variety of investments, including property, but there are various rules and regulations to keep in mind. Additionally, you are only allowed to buy an investment property through an SMSF, and not a place for you or your family to stay.
If you’re buying property through an SMSF trust, it must meet the requirements of the sole purpose test. The ATO states that an SMSF must be operated solely to provide retirement benefits to its members. It means an investment made through the trust should not provide any immediate benefits to the trust members or their families.
If any of the members or somebody else related to them uses the property for their own benefit, it will fail the sole purpose test. It means you can’t buy a house through an SMSF and rent it out to your family or use it as a holiday home during summer. It’s just like you can’t purchase a piece of art using SMSF funds and hang it on your wall for decoration.
Breaching the sole purpose trust can have severe legal and financial consequences for the trustees. It’s advisable to talk to an expert to understand your obligations and responsibilities, as well as the costs involved in setting up an SMSF, if you are considering such an arrangement.
Here’s a set of rules you need to follow when buying a property via an SMSF:
- The property must meet the sole purpose test. It should be purchased only for the purpose of providing retirement benefits to fund members.
- You must not buy the property from a fund member or somebody related to them.
- You, your family, any other fund members and their related parties aren’t allowed to live on the SMSF property.
- If the SMSF buys a commercial property, a fund member may lease it for business purposes, but only at the market rate and in accordance with any applicable rules.
Can you borrow money to buy a property through an SMSF?
An SMSF cannot generally borrow funds except for limited borrowing recourse arrangements (LRBA). An LRBA is a lending arrangement where an SMSF trustee takes out a loan from a third-party lender to purchase a single asset that must be held in a separate trust.
The aim of introducing a limited recourse arrangement is to protect an SMSF’s other assets in case of a payment default. Generally, when a borrower defaults on a loan, the lender can access most of their assets as recourse. However, under an LRBA, if your SMSF defaults, the lender only has recourse to the property that was purchased using the SMSF loan.
While this kind of arrangement helps protect the other assets in an SMSF, it also increases the risk to the lender by limiting their recourse in case of default. This naturally leads lenders to apply strict eligibility criteria for SMSF loans, including higher deposits. Additionally, redraws are generally not allowed on SMSF loans, but it may be possible to refinance an SMSF loan depending on the terms of your agreement.
Lenders also require you to have sufficient funds in the trust before approving you for an SMSF loan. It’s worth speaking to a mortgage broker or a lender to understand the minimum eligibility criteria before applying for a loan.
There are a few other things you should consider before applying for an SMSF loan:
- Your trust deed and SMSF investment strategy
If you’ve set up a self-managed superannuation fund, you’ll have a trust deed that sets out the rules for establishing and operating the trust. SMSF trustees are also required by super laws to prepare and implement an investment strategy. This strategy must set out what the fund can invest in, and all investment decisions should align with this strategy.
If you wish to borrow money to buy an SMSF property, this must be mentioned in your investment strategy and trust deed. It’s worth reviewing these documents before applying for a loan or purchasing property to ensure you don’t defy any applicable rules.
- Renovation restrictions
Besides strict eligibility criteria, the rules around an LRBA might restrict the improvements you could make to an SMSF property. While you can use the fund money for regular repairs and maintenance, any major renovations are not allowed while the SMSF loan is outstanding, as it can change the property’s ‘inherent character’. You should also note that SMSF trustees may not borrow money to improve an asset.
Is it worth buying property through an SMSF
Whether or not investing in property is a sound decision for an SMSF is hard to say. There are several pros and cons to this strategy, and the right choice will generally depend on the SMSF’s overall objectives. The costs of investing in a property (like stamp duty) and complex rules around the usage of a property can make it look like a tricky proposition. On the other hand, various tax deductions and the potential for wealth generation through property appreciation can make property investment through SMSF a lucrative option.
If you’re toying with the idea of purchasing a property through an SMSF, it’s recommended to speak to financial and legal experts to understand the various rules and regulations. If your trust doesn’t hold the funds to buy a property outright and you’re considering an SMSF loan, speaking to a broker can help you determine your eligibility and the various costs you might incur. This will make it easier for you to make an informed decision.
