The love affair that Australians have with property as an investment can provide real benefits, depending on the age and stage of life of the owners. It can also lead to property being owned by a self-managed superannuation fund. Owning a property in an SMSF can provide benefits depending on the type of property and the age of fund members.
The most common form of investment property is residential. A popular strategy is for the high-income-earning and high-taxpaying member of a couple to negatively gear a rental property. In this situation, a tax loss is made that produces a tax refund.
Under this strategy the investor is seeking to generate large capital gains from the property. For the strategy to work, the capital gain needs to exceed the combination of the original purchase cost and the accumulated net after-tax holding cost of the property.
It is also not uncommon for people who use this strategy to pay off the mortgage on the property over several years so that they can receive the rental income in retirement. In some cases super funds are withdrawn to pay off loans. This results in the income received being fully taxable and the income received is much lower than other investments.
Another disadvantage of the strategy is that at some point capital gains tax will be payable, either when the property is sold by the original investor or when it is sold on their death. It is best to anticipate these problems and put in place strategies to deal with them.
One strategy is to sell the investment property after the owner has retired and before they turn 65. This will mean the tax payable on the capital gain can be reduced by making a self-employed super contribution. In addition, the net proceeds can be paid into a super fund as a non-concessional contribution to produce a tax-free income in retirement.
A big problem of having a negatively geared property in a super fund is the drain on the cash flow of the SMSF. This occurs because the rent received is much less than the expenses, including loan repayments. This means most of the contributions, or investment income, are used to meet the cash-flow shortfall rather than increasing superannuation benefits.
Even if no borrowings have been used to buy a residential property, cash-flow problems can occur for a super fund when members start pensions.
This results from the net rental income of residential property in most cases being less than 3 per cent, while the minimum pension payment requirement is at least 4 per cent of the value of the property.
The longer a property is held by the fund, the more other investments must be sold to meet the minimum pension payment requirements. The cash-flow problems can be compounded for an SMSF when there are long periods of either rental arrears or no tenants.
It therefore also makes sense for the trustees of an SMSF to plan to sell a rental property. The best time for this is after pensions have started as no capital gains tax will be payable.
A property strategy that can be very effective for an SMSF is when the members want to retire to a location that is different from where they now live. This results in the super fund buying a property at today's prices that is later transferred in specie to the members on their retirement.
Frequently Asked Questions about this Article…
What benefits can owning property in an SMSF (self-managed super fund) provide for everyday investors?
Owning property in an SMSF can provide real benefits depending on the type of property and the age and stage of fund members. Strategies include buying property for long-term capital growth, transferring a property in specie to members when they retire (so they can live in it), and using sale proceeds strategically (for example, contributing proceeds into super as a non‑concessional contribution to produce tax‑free income in retirement).
How does a negatively geared residential investment property strategy work for high‑income investors?
A common approach is for the higher‑income member of a couple to negatively gear a rental property, creating a tax loss that can produce a refund. The investor’s goal is capital gains large enough to exceed the original purchase cost plus accumulated net after‑tax holding costs. Some investors also aim to pay down the mortgage so rental income can be received in retirement.
What are the main drawbacks of holding a negatively geared property inside an SMSF?
A big drawback is the cash‑flow drain: rent often falls short of expenses (including loan repayments), so most contributions or investment income are used to cover the shortfall rather than grow super benefits. There’s also the eventual capital gains tax liability when the property is sold (either by the owner or on death), and cash‑flow pressure can worsen if there are long periods without tenants or rental arrears.
Why can residential property cause cash‑flow problems for SMSFs when members start pensions?
Net rental income from residential property is often less than 3%, while the minimum pension payment requirement is at least 4% of the property’s value. That gap means the fund may need to sell other investments or use contributions to meet pension payments, and problems are compounded by vacancies or rental arrears.
When is a good time for an SMSF to sell a rental property to minimise tax and cash‑flow issues?
It makes sense for trustees to plan to sell a rental property after pensions have started, because no capital gains tax will be payable then. Selling between retirement and age 65 can also be beneficial: the owner can reduce tax on the capital gain by making a self‑employed super contribution and then pay net proceeds into super as a non‑concessional contribution to create tax‑free retirement income.
How can selling an investment property be used to reduce capital gains tax for SMSF members?
One strategy is to time the sale after retirement but before turning 65 so the seller can make a self‑employed super contribution to reduce tax payable on the capital gain. Additionally, net proceeds can be contributed into super as a non‑concessional contribution, which helps produce tax‑free income in retirement.
Can an SMSF buy a property now for use by members when they retire in a different location?
Yes. A practical SMSF strategy is to buy a property at today’s prices in the location members want to retire to, then transfer that property in specie to the members on their retirement so they can move without having to buy at future prices.
Should SMSF trustees proactively plan for property ownership and possible sale?
Yes. Trustees should plan ahead to manage cash‑flow shortfalls, minimum pension payments and future capital gains tax. Planning the timing of a sale (for example, after pensions start or between retirement and age 65) and considering contribution strategies can reduce tax and help ensure the fund meets pension obligations.
Call 1300 880 160
Start a chat
Schedule a call
