Legislation allowing Self Managed Super Funds (SMSFs) to borrow has encouraged a growing number of SMSFs to use borrowed money to gear into property, both commercial and residential, via a limited recourse borrowing arrangement (LRB). Limited recourse essentially means no other assets of the fund are used as security for the loan. In the event of a default, only the geared asset itself can be sold to cover the loan.

There is no doubt about it, Australians have a passion for holding property as a geared investment outside of super, mainly due to the significant tax benefits on offer. Aussies love to drive past, see the property and provides them with a perceived sense of security. This Aussie attraction to property (bricks and mortar) has now extended to gearing property in the ever-growing SMSF environment.

It’s like going to the races and winning a trifecta on the races. Many Australians have their own home, and have a negatively geared investment property and now a geared property in their SMSF. A great trifecta! Or is it?

So what are the real benefits in owning a property in a SMSF?

1. Shares and property have historically been the best performing asset classes over the long term. Gearing is a way smaller funds can access both these investment classes to maximise diversification. Certainly we are seeing more and more SMSFs being set up by younger people who cannot access their super money until age 65 or beyond wanting to borrow to invest into property.

2. The possibility of selling the property tax-free in the future when the fund is in pension mode.

3. The attractiveness of selling a property after it has made substantial gains over the long term at a discount capital gains tax.

So what are the negatives?

1) It is not cheap to set up the legal documentation to gear into a property via an SMSF. A “Bare Trust” needs to be established to hold the property. There are also stamp duty and legal costs.

2) Let’s not forget the maximum tax rate a super fund pays on earnings is 15% which is a very low tax rate. Hence, negative gearing benefits will be much lower, requiring the property that you purchase to show strong capital growth to recuperate the after tax losses as compared to investing as an individual tax payer on the top marginal tax rate. For example, a $100 tax deduction only provides an SMSF with a $15 benefit, compared with a $46.15 benefit to an individual on the highest marginal tax rate.

3) Having one major asset (i.e. a property) owning a substantial amount of your SMSF.

4) Property, as most people will know, is an “illiquid asset” which may not be generating enough cash to make required pension payments. Owning property in an SMSF for those nearing retirement is really not a good strategy.

5) Consider the risk associated with borrowing in an SMSF, especially if the property is vacant for long periods of time.

6) Getting a bank loan. Most banks today will have a minimum amount of money to be held in an SMSF before they will even consider lending money to your SMSF.

7) Understand the complexity of the rules for Limited Recourse Borrowing (LRB). These super borrowing rules place restrictions on what you are allowed to do with the property. Upgrades and additions to the property are difficult to do within a SMSF with a LRB arrangement in place.

As always, we strongly recommend Trustees should seek the appropriate advice from their financial adviser before considering having their SMSF borrow to invest to acquire a property.

Property and self managed superannuation

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David Watkins, has been providing advice to clients since 1987. He is a Certified Financial Planner, a member of the Financial Planning Association (FPA), and Superannuation Professionals Association of Australia (SPAA).Google Plus

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