If you have your money in a self-managed super fund (SMSF), to say the past eighteen months have been a little stressful is probably a giant understatement.
While the GFC sent stock prices bipolar you’ve had to sit and watch property prices rise, wishing there was a way to put some of that hard earned money to work in bricks and mortar. As it happens, there is.
Change in rules for borrowing against SMSFs
Back in September 2007 the rules governing self managed super funds (SMSFs) changed so that you could use your super funds to borrow to invest in an asset, such as property.
Up until then, if you wanted to buy property, your fund had to purchase it outright. But now you can borrow anywhere from 60-75% of the property value depending on the type of property and lender.
So if you have – or are considering – a SMSF, this could be a great way to leverage super to grow your assets – and gain some impressive tax benefits too.
What sort of property can I buy?
Through your fund, you can borrow to purchase property such as residential, commercial, retail, rural and holiday apartments. It’s important to remember that this is for investment property only so you can’t move in.
How does it work?
In plain English rather than excruciatingly jargon filled detail (best left to your financial advisor):
- You get a lawyer to establish a property trust outside your fund.
- You find a property, pay a deposit and borrow the rest from a lender through your SMSF.
- The Property Trustee purchases the property and becomes the legal owner.
- The Property Trustee grants a real property mortgage over to your lender.
- Rent from the property is paid into your SMSF.
- You pay off the loan to the lender through your SMSF.
- The beneficiary of the property is your SMSF.
What are the benefits of borrowing for property through your SMSF?
While advantages will differ from person to person, they include:
- the ability to leverage an asset
- tax savings and benefits
- it gives you diversification of investment from shares or managed funds
- 10% capital gains if you hold the property for more than 12 months and potentially nil if the property is sold when the fund is in pension phase
- tax deductible interest costs the bank or lender has no access to other assets in your SMSF.
- rent generated from the property does not count as a taxed contribution.
Can you borrow to invest in property?
Things you need to take into account:
- Do you have the cash flow and capacity to service the loan? The bank will value the property and decide whether the rental income and any additional super contributions you make can cover the loan. Depending on whether you buy commercial property or residential property can have a bearing, especially as interest rates rise.
- Does your SMSF permit this type of borrowing? You need to make sure that your trust deeds allows it, and you might need to provide provisions for it to do so. Have this checked out by your lawyer.
- Does it work with my investment strategy? A discussion with your investment adviser would be important in this situation.
- Can I cover additional costs? Your SMSF is responsible for rates, land tax, interest and loan repayments, lender’s fees, legal and accounting fees, repairs, property management costs, insurances, etc
Example of buying property through a self-managed super fund
Sam the butcher turned 50 on the weekend. Happy birthday Sam. He earns $64,400 a year plus 9% super that goes into an industry fund. He’s also got $138,000 in savings.
Sam wants to build up his nest egg for retirement with a property investment so he checks out a tip from one of his regulars and sets up a SMSF. Instead of rolling over his industry fund, he decides to use the $138,000 as a deposit.
He finds a house that costs $480,000 and borrows $342,000 via his fund. After 10 years of capital growth at say, 4%, the value of the property is $680,912. Assuming 7.5% interest p.a. over the 10 years he owes $177,813.
Because Sam has been salary sacrificing, his tax on contributions is 15%. If he’d been paying outside his fund, he would have had to pay 31.5% including the Medicare levy.
Sam decides to sell his property and now has $503,099 in his fund – instead of $396,793 – making him $106,306 better off…and laughing ’til the cows come home.