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 In some cases super funds are withdrawn to pay off loans.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 are the main benefits and risks of owning property inside an SMSF (self‑managed super fund)?
Owning property in an SMSF can provide long‑term benefits depending on the type of property and the members' age and stage of life, such as potential capital growth and a tailored retirement strategy. Risks include cash‑flow pressure (especially if the property is negatively geared or vacancy/arrears occur), possible taxable income if loans are repaid from super, and capital gains tax consequences when the property is sold or on the owner's death.
How does negative gearing work in an SMSF and why do investors use it?
Negative gearing in an SMSF means the rental income is less than the expenses (including loan repayments), producing a tax loss that can generate a refund for high‑income investors. The strategy is used by investors aiming for large capital gains that exceed the purchase cost plus accumulated after‑tax holding costs.
How can negative gearing drain an SMSF’s cash flow and affect retirement income?
A negatively geared property can create a cash‑flow shortfall because rent often doesn't cover expenses and loan repayments. That shortfall may be met by member contributions or other investment income, reducing the fund’s capacity to grow. If super is later withdrawn to pay loans, the resulting rental income can become fully taxable and typically produces lower retirement income than other investments.
When will capital gains tax (CGT) be payable on an SMSF investment property?
Capital gains tax can be payable when the property is sold by the original investor or when it is sold on their death. The article suggests anticipating these CGT implications and putting strategies in place to reduce the tax impact.
How can selling an investment property after retirement but before age 65 reduce capital gains tax?
Selling a property after you retire and before turning 65 can reduce the tax payable on the capital gain by making a self‑employed super contribution. Additionally, net proceeds can be contributed as a non‑concessional contribution into super to potentially create tax‑free income in retirement.
Why can residential property create cash‑flow problems for an SMSF once pensions start?
Residential rental income is often less than 3% net, while the minimum pension payment requirement is at least 4% of the property’s value. That gap means the SMSF may need to sell other investments to meet pension rules, and problems worsen during long vacancy periods or rental arrears.
When should SMSF trustees plan to sell a rental property to avoid tax or cash‑flow issues?
Trustees should plan to sell rental property after pensions have started because, according to the article, no capital gains tax will be payable once the fund is in pension phase. Selling at the right time can also help manage ongoing cash‑flow pressures.
What is an in specie transfer and how can it support a retirement relocation strategy?
An in specie transfer involves the SMSF buying a property now (at today’s prices) and later transferring that specific property directly to members on retirement. This can be effective when members plan to retire to a different location than where they currently live, allowing the property to be used as their retirement home.
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