Since changes to superannuation legislation in 2007, which allowed for self-managed super funds (SMSFs) to borrow money for property assets, there has been a dramatic increase in the number of people setting up a SMSF in order to purchase an investment property. Whilst there are many benefits to this, there are strict rules which must be followed.
The primary benefit of purchasing property through your super fund is the potential tax benefits. For example, where an investment property is purchased outside of super and then sold to fund your retirement, the sale will be subject to capital gains tax. If you were to purchase the same property through your SMSF, the tax burden could potentially be reduced to zero provided the property is sold after your super fund switches to pension phase. If the property is sold by before you retire a maximum 10% capital gains tax is payable, provided the property has been owned for at least 12 months. This could result in savings running in the tens of thousands of dollars.
Alternatively if you continue to rent out the property during the pension phase the rental income is only taxed at 15 per cent, rather than your personal tax rate.
It sounds simple right? Unfortunately there are a couple of negatives that you need to be aware of. Firstly setting up a SMSF can be a costly and complicated process. On top of this when borrowing lenders typically will only lend around 65-70% of the purchase price to a SMSF and often charge a higher interest rate.
The loan must also be what is termed a non-recourse loan, meaning that the property itself must be the only asset provided as security for the loan. On top of this a SMSF cannot develop or improve a property that has a mortgage over it, with the loan having to be fully paid out before any improvements to the property can be made.
The property is also subject to the sole-purpose test, meaning that it must be owned purely for the purpose of investing for retirement, so it can’t be lived in, used as a holiday home or rented by a member of the SMSF, or any related parties of a member.
The safest bet is to ensure that you have the capacity to fully pay out the mortgage on the property prior to retirement; otherwise servicing the loan could prove difficult.
It is important to seek financial and legal advice before purchasing an investment property through a SMSF as the ATO watches these types of investments very closely.