Australia’s love of property is well documented. To a lesser extent, so too is the increasing number of people who think they can do a better job investing their superannuation than the professionals.
It’s not surprising therefore that the number of people combining property and superannuation and using a self-managed super fund (SMSF) to invest in direct property is growing steadily.
Does combining Property and Superannuation make sense?
But before deciding on a final stand, there are a number of issues that demands consideration..
While successful property investing can be challenging enough in the current and prospective market climate, holding a property asset in an SMSF only adds a layer of extra complexity.
Restrictions on Property and Superannuation
Superannuation law imposes a range of rules and restrictions that don’t apply when investing in property outside super.
For example: SMSFs can’t be used to buy residential property from any member or related party, but only from the open market.
Funds members and relatives living in residential property will be judged as an offence and serious breach of our code to serve people with impartiality. This test also imposes a limit on the extent to which SMSFs can enter into lease arrangements and certain other transactions with related parties.
The trustees must formulate an investment strategy that is specific and suitable to the whole circumstances of the fund. This includes factors such as the members’ age, risk profile and retirement objectives, as well as the need for diversification.
Moreover, plans should also be made to address the lack of asset diversity over time.
Wondering if using a Self Managed Superannuation Fund to invest in property is the right thing to do?
Consider the fund’s capacity to meet current and future expenses, such as insurance premiums, property repairs and maintenance, tax liabilities and interest payments (if an LRBA is established) before deciding and reaching any conclusion.
In case of the rental income failing to meet ongoing liabilities, the trustees will need to ensure that either the fund holds sufficient cash or the members have capacity within their caps to make additional superannuation contributions.
SMSFs intending to invest primarily in direct property should also consider how they would deal with having to pay out a sizeable portion of the fund’s value.
This could occur if a member decides to exit the fund and wants to rollover their benefit.
Other scenarios could include if a member divorces, suffers a total and permanent disability or passes away.
If the property has to be sold to fund a benefit payment or rollover, it may take a while to find a buyer, the selling price may be lower than anticipated and the return on capital may not meet the member’s or fund’s expectations.
SMSFs that hold large lumpy assets like property should consider insuring the members in the event of death or TPD, if allowed in the trust deed.
Not only can this be a cost-effective way to fund the insurance cover, it can help ensure a ‘fire sale’ isn’t required to pay a death or disability benefit.
Repairs, improvements and replacements
Before using an LRBA to acquire a property in an SMSF, it’s important to be aware that while the property can be repaired or maintained using some of the borrowed money, improvements can only be funded using cash-flow, other fund assets or additional contributions.
Also, it is generally not possible to replace or redevelop a property that is subjected to an LRBA. This is because if work is done that fundamentally changes the character of the property, it can no longer be held in the existing LRBA.
A key exception is where a property that is severely damaged or destroyed by events such as flood or fire is replaced with a like property using the proceeds from an insurance policy.
For example, replacing a destroyed four-bedroom house with a similar four-bedroom house would generally be considered acceptable, whereas building two townhouses with two bedrooms in each would usually not.
These concepts are discussed further in the ATO’s Self Managed Superannuation Funds Ruling SMSFR 2012/1.
Property and Superannuation – The Bottom Line
Investing in property through an SMSF could be a worthwhile and rewarding strategy.
However, you should most probably avoid this option if you wish to buy a residential investment property for your own enjoyment or want to start a property development business through your SMSF.
Furthermore, even if the investment is made for the right reasons, cash-flow problems could arise if the property is untenanted for a significant period, or a large sum of money needs to be paid out and there isn’t sufficient liquidity available.
Naturally in all matters of finance, investors are encouraged to seek expert legal, taxation and financial advice before undertaking this strategy.