InvestSMART

Super draft to make property breezier

The fact you can do something doesn't mean you should do it. That's sage advice indeed from Tax Office assistant commissioner, Stuart Forsyth, on super fund borrowings.

The fact you can do something doesn't mean you should do it. That's sage advice indeed from Tax Office assistant commissioner, Stuart Forsyth, on super fund borrowings.

The property spruikers have been hailing a Tax Office draft ruling released this week as a win because it removes some of the potential traps in borrowing to buy property through a self-managed super fund.

But while the ruling makes it easier to undertake legitimate investments, investors still need to beware of smart salesmen making big promises.

While the official Tax Office stats are not showing a big pick-up in super fund borrowings, there is growing interest in gearing up the self-managed super fund to invest in property.

Service provider Multiport found 14 per cent of the 1600 self-managed funds it administered had a borrowing arrangement in June, with 52 per cent borrowing to buy property and 48 per cent to buy financial assets. The average property loan size was $200,000 versus $110,000 for financial assets.

And why not? Australia's love affair with property is well known, but you would need a sizeable super fund to cough up the price to purchase outright any sort of decent property investment.

The limited recourse borrowing arrangements that super funds are allowed to use give people the ability to use someone else's money to build up a property investment for the future, while protecting any other assets of the fund from the lender if things go bad.

As only limited recourse borrowings are allowed, lenders cannot be given any rights over other assets held by the super fund. But use of borrowing has been stymied by the apparently draconian legislation introduced to stop people from rorting the rules.

Two areas, in particular, have acted as a big stop sign to prudent investors and it is these areas that the draft ruling aims to clarify.

Under the legislation, borrowing arrangements by super funds must be used to buy a "single acquirable asset". Borrowings can also be made for the costs of maintaining or repairing the acquirable asset but not expenses incurred in improving it.

While there are exceptions for assets such as shares, the industry's interpretation of the legislation has been that super funds could run foul of the law by borrowing to buy property that could arguably be said to comprise more than one asset. One example is a factory built on two adjoining land titles.

After the Queensland floods this year, concerns were also raised that super funds could run into problems replacing destroyed assets as this could, under the legislation, be deemed to be a separate asset requiring a new borrowing arrangement.

The question of improvements was also tricky as many experts felt the law could prohibit any improvement of the property at all - even if it was funded from sources other than the super fund.

The draft ruling has been put together following consultation with the industry and adopts a commonsense approach to how the legislation should be interpreted.

The factory, for example, would be regarded as a single asset because effectively it can only be dealt with as one asset.

That is different to the example of a farm spread over two land titles where, despite being used as a single asset now, there is no obstacle to part of the farm (one of the titles) being sold, leaving the farming business to be conducted on the remaining land. This would not be regarded as a single asset for borrowing purposes.

In terms of the property that needs to be reconstructed after a disaster, the ruling makes clear as long as the reconstruction returns the property to what it was before, it is not regarded as a different asset under the borrowing rules. But if you replaced a single four-bedroom house with two two-bedroom units you'd have a different asset and fall foul of the rules.

The Tax Office also clarified questions about what qualifies as repairs versus improvements.

While there are always grey areas, it says an improvement is something that significantly increases the functionality or value of the property - not something that only results in a minor change in value.

The ruling is less clear on the vexed issue of how off-the-plan property purchases are regarded.

Depending on how these deals are structured, buyers could commit initially to a contractual right or option to buy the unit, which is a separate asset to the unit itself.

The ruling indicates in such instances, if the payment made to secure the purchase of an apartment off the plan was not borrowed, the trustees could enter into a borrowing arrangement to complete the purchase once the unit was completed.

As Forsyth emphasises, the draft is merely that. It is now open for consultation and will almost inevitably be amended before the final version is issued. But it provides a useful guide to Tax Office thinking on what should, and should not, be allowed.

Ultimately it isn't the property developers or even the accountants who are responsible for making borrowings work. While Forsyth says the Tax Office will be focusing on making sure advisers do the right thing, it is self-managed fund trustees who are in the hot seat.

A borrowing strategy may be a great way to boost your retirement savings, but the penalties for getting it wrong can be severe - in terms of the tax law and your retirement lifestyle if the strategy doesn't pay off.


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