Gearing in DIY funds under threat

SMSF borrowing arrangements are at risk of change from the FSI’s final report.

Summary: The Financial Services Inquiry’s final report is unlikely to make changes to property gearing in SMSFs retrospective. Existing arrangements are likely to be grandfathered if gearing in super is banned. But the government could take a number of different views on what constitutes an existing arrangement.

Key take-out: If you are actively considering investing in a geared property in an SMSF, be wary that any rule changes could leave you in an awkward and costly position.

Key beneficiaries: SMSF trustees and superannuation accountholders. Category: Superannuation.

Property gearing in SMSFs is under the gun with the powerful Murray Financial Services Inquiry preparing to hand down its final report.

If the government makes announcements at the same time that the final version of Murray’s FSI is released, it would appear anyone who is currently considering a geared property investment in their SMSF, but not bedded down in one, could face potential problems.

Even some of those who have signed contracts could be in trouble, depending on which stage of the purchase the buyer is in.

It is considered unlikely that any changes would be retrospective. Making SMSFs who have paid hundreds of thousands of dollars for any investment, including often tens of thousands of dollars in stamp duty, sell their investment (usually incurring sales costs of 3% or so) would be disastrous for a lot of SMSFs.

Particularly those who have bought and are currently underwater, but who would otherwise be willing to ride out any underperformance.

If a ban were implemented, existing arrangements are likely to be grandfathered. And future arrangements could be banned. But what about those in progress?

The issue would likely then become what constitutes an “existing arrangement”.

DBA Lawyers’ Bryce Figot has pointed out that a government could take a number of different viewpoints. This could include when the purchase contract is signed, when a deposit is paid, when a bare trust deed (to hold the property in a SMSF) is signed, when a loan contract with a lender is signed or when the property settles.

Figot says that when the government last changed the rules – in 2010 when it switched the former “instalment warrant” rules for the current limited recourse borrowing arrangement (LRBA) rules – it took the view that it was when the loan contract with the lender was signed.

There is no guarantee that they could or would choose a similar definition.

So where would that leave those at varying stages of the buying process now? In particular, what about those who were buying off-the-plan properties that aren’t due to be completed for some time?

In most off-the-plan property developments, banks won’t offer financing until the property is near completion and they can get some sort of reasonable valuation on the property. Buyers are often signing contracts to buy, without secure knowledge that they have borrowings to complete the purchase.

“There is a real possibility that the limited recourse borrowing arrangement borrowing exception laws might have been repealed by (the time a building is ready for loan funding),” Figot wrote.

Murray’s FSI interim report specifically called for submissions on whether LRBAs, or more specifically borrowing in SMSFs, should be banned. And if you don’t believe the lobbying power of the APRA-super sector, who are bleeding customers to the now one-million-member strong SMSF sector, you’re living under a mushroom.

Geared property in super is a big drawcard into SMSFs at the moment. It is, unfortunately, attracting some people who shouldn’t be gearing into super (see The super property end game). In my opinion, if you haven’t geared into property outside of super, you probably shouldn’t be gearing into property inside an SMSF.

But from right now … if you are actively looking for, or considering, investing in a geared property inside an SMSF, just be wary that if the rules change, you could be caught in an awkward, and costly, position.

The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.

Bruce Brammall is director of Castellan Financial Consulting and the author of Debt Man Walking. E:

  • Self-managed super funds are now the largest component of Australia’s superannuation pool, at $550 billion or over a third of the pool, a report from UBS and the Financial Services Council found. The number of SMSFs has grown by around 30% since 2009, according to the report.
  • The majority of assets held in SMSFs are in cash, at 35%, the FSC-UBS report found. Domestic equities make up 23% of assets held, managed funds 15% and direct residential property 7%.
  • The free trade agreement could open the Chinese market to Australia’s superannuation industries, says SMSF Professionals’ Association of Australia managing director Andrea Slattery. “There will be opportunities across a range of services, including financial advice, fund administration, system design, retirement income policy expertise and complex data storage, security and management,” Ms Slattery said.

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