Trustees investing in real estate must keep an eye on the details or could find themselves in serious trouble.
The Australian Taxation Office (ATO) is warning trustees of the rapidly growing self-managed superannuation funds (SMSF) sector to be cautious when investing in property.
The acting commissioner of the ATO, Bruce Quigley, says some trustees are using their superannuation funds to invest in property without fully understanding their legal obligations, or are deliberately trying to skirt the law.
Breaches of the law can result in a fund's trustees being disqualified, civil penalties or even criminal charges. Fines of up to $220,000 can be applied to trustees entering into arrangements that are not properly structured.
Over the past five years, the rules have been progressively relaxed. Trustees can now borrow to invest in property through their funds. Previously, property could only be held outright inside a fund.
The change to allow the gearing of property inside SMSFs and the poor performance of shares since the onset of the global financial crisis have spurred a growth in "opportunities" on the internet. Property companies are recommending investors start an SMSF so that tax savings can be enjoyed by holding the property inside super.
The growth in SMSFs is too good an opportunity for property spruikers to miss. Data from the Tax Office shows there were about 478,000 SMSFs, holding more than $439 billion in assets, as at June 30, 2012, an increase of almost 8 per cent in the number of funds from a year earlier and about 15 per cent more than at June 30, 2010.
Those pushing real estate in super can be anyone from developers, real estate agents and mortgage brokers, to self-described property "specialists" and "researchers". Commissions and kickbacks are likely to be going back and forth between developers and those pushing the attractions of property online. Sometimes they are also arranging the financing.
There are players coming into the SMSF space with too many tricks, says Ian Robertson, a chartered accountant and financial planner at IAC Robertson & Co, which is a member of Count Wealth Accountants. There are some compelling reasons for holding real estate inside a self-managed super fund, but investors need good advice and the investment strategy needs to fit the investor's risk profile, Robertson says.
The Tax Office, which regulates the SMSF sector, says those marketing properties to SMSF trustees who are believed to be doing the wrong thing could be referred to the corporate regulator, the Australian Securities and Investment Commission (ASIC).
The commission has recently said it is examining the aggressive marketing of property developments to investors who are being advised to set up their own SMSF to hold the real estate.
The correct sequencing of the arrangements and the proper documentation are essential, says the head of technical services at self-managed superannuation funds administrator Multiport, Philip La Greca. Geared property is not held directly in the fund. When done properly, the property is held in a holding trust, which is a separate legal structure, with the SMSF as the "beneficial owner" of the property, La Greca says.
The SMSF has to be established first, before the contract of sale for the property is signed, he says. Trustees have to be careful to have the correct name or names go onto the title of the property, and the mortgage documents and the wording of the contracts of sale need to be checked carefully to make sure all the correct procedures are followed, La Greca says.
Quigley says the Tax Office has seen instances where holding trusts have not even been established at the time the contracts to acquire are signed.
The Tax Office has also seen instances where the borrowing and title of the property are held in the wrong names.
"Some of these arrangements, if structured incorrectly, cannot simply be restructured or rectified," Quigley says.
"The only option may be to unwind the arrangement, which could involve the forced sale of assets at an inconvenient time. This could be very expensive for the fund with potential stamp duty and tax consequences."
The Tax Office is also concerned that certain borrowing arrangements entered into by SMSF trustees to buy property do not comply with the superannuation laws. Under the rules, the mortgage used to fund the purchase must be "limited recourse", which means the lender has no recourse or call on the SMSF's other assets, other than the property, in the event of a default on the mortgage.
"I urge trustees to get reliable, independent advice when making investment decisions and to obtain advice from us if they are contemplating entering into these sorts of arrangements," Quigley says. "The responsibility for ensuring their SMSF complies with the law rests with them."
Details of the Tax Office's concerns can be found in the ATO Taxpayer Alert TA 2012/7, "Self-managed superannuation funds arrangements to acquire property which contravene superannuation law". See ato.gov.au and search for "taxpayer alerts".
- The rules on SMSFs investing in property have been relaxed during the past five years, but the Tax Office is warning trustees to know and comply with the laws.
- Breaches of the law can result in a fund's trustee being disqualified, civil penalties or even criminal charges.
- The corporate regulator is examining the aggressive marketing of property developers to investors, who are being advised to set up their own SMSF to hold real estate.
- Proper documentation is essential.
- Property is to be held in a holding trust, which is a separate legal structure.
Beware of traps
Those thinking of investing in property though a self-managed superannuation fund need to have their eyes wide open, says chartered accountant and financial planner Ian Robertson of IAC Roberston & Co. Under the super rules a certain minimum percentage of the SMSF's assets must be drawdown in pension phase.
The actual minimum percentage depends on age. But it is likely that the net yield on investment property will be lower than the minimum to draw down and trustees may not have sufficient income from the property to meet the minimum drawdown, Robertson says.
That means investors will have to rely on other assets in their fund, such as shares and cash, to make the minimum drawdown. And it may not be a good time to sell. "You should not have a self-managed superannuation fund that is solely invested in residential real estate," Robertson says. Investors should consider how the mortgage repayments and expenses of holding property would be met if the property was vacant with no rent coming in. Mortgage repayments would have to be met from other investments held in the SMSF.