Understanding property investments in your SMSF

The well of interest in property in SMSFs is certainly deepening.

It’s partly low interest rates and the flat-lining of property prices in most states for some years. Take into account inflation and most state capitals have gone backwards.

It’s also got a lot to do with that lower volatility of property. Property returns have been very ordinary in recent years, but ordinary is far better than a 55% crash, as we experienced in equities between late 2007 and early 2009.

And we shouldn’t ignore the changes to the law in recent years, which have added the dimension of gearing to super.

A big thank you to those who tuned in to the Eureka Report SMSF Property webcast on Monday. We seemed to have got through about two dozen questions. But when the hour was up, there were plenty that hadn’t been answered. So, today I’ll answer as many more of those that I can.

Can I sell my residential investment property into my super fund?

No. Simple. Under the rules, a SMSF cannot buy a residential property from a related party to the fund. The ATO doesn’t trust that you would do the transaction at arm’s length. If you sold it to your super fund for too low a price, you might effectively be making extra contributions to your fund. If you sold it to your super fund for too high a price, then you would be getting a benefit from your super fund. This rule is unlikely to change. (How popular would it be if it was allowed?)

Can you just clarify the matter of borrowings? Someone said “no borrowings” but I constantly hear bank lending as part of the mix?

Sorry, Anthony and I did talk about this a few times in the webcast. And it can be confusing. SMSFs can either purchase property with cash, or they can borrow through “limited recourse borrowing arrangements”.

The “no borrowings” comes in regards to renovating or developing a property. If you’re using an LRBA to purchase a property, then the property needs to be established, or at least finished, or potentially purchasing something off the plan that will be finished when you take control of the asset. You can’t buy some land, then use borrowings to build a dwelling on it. Further, you can’t build extensions or even do renovations with borrowed money.

Can you improve the property if there is no debt in buying?

Yes, a SMSF can improve, renovate or even develop a property, so long as it is using its own cash. No borrowings are allowed.

Our accountant has told us that if we purchased a property in our SMSF we could not substantially change the property (i.e. no development). Is this because the SMSF is borrowing to make the purchase?

It sounds like the conversation with the accountant has been around purchasing a geared property at the outset. If that’s the case, the accountant is right. You won’t be able to develop a property with gearing on it, or use borrowings to develop the property.

Property with higher land content is preferable to apartments, but what about townhouses? A better balance between rent yield and capital growth?

Both Anthony and myself share a view that property has to have reasonable land content as part of its value. Neither of us believe that flats make great investments. The higher the land content the better, as “land appreciates and buildings depreciate”. Flats tend to have as little as 10% or 20% land value.

I don’t mind townhouses, so long as they have reasonable land content in the valuation, which preferably includes their own yard or courtyard. It’s simply about the land.

If a property is sold when the fund is in the pension phase, is capital gains tax payable?

No. Assets backing a pension in super are tax-free assets. If the property is positively geared, there is no tax to pay on the income being generated. If the property is sold, and the property is part of the pension fund, then there’s no capital gains tax payable on the asset.

If your SMSF is in pension mode, is there any benefit of purchasing a geared investment property inside the SMSF rather than purchasing it say in joint names outside your SMSF?

There can be a benefit, under some circumstances, but it depends on what you are trying to achieve.

If the intention is to reasonably fully gear the asset, then you need to understand that a negatively geared property doesn’t have much value in a SMSF pension. A negatively geared property means it has negative income – not much use in an environment where no tax is being paid anyway.

In most cases, yes, you would probably be better off buying geared property in personal names. (However, depending on how long you’ve had a pension, you will find restrictions from lenders on the loan term they are prepared to lend on.)

The circumstances where it might still make sense for a pension fund to own a geared property might include where the property is neutrally or positively geared. The gearing allows you to control a larger asset base that you would otherwise be able to control. And this might appeal to some members/trustees.

Why does it cost so much to get a certificate of independent financial advice? These seem to be prerequisites for establishing a limited-recourse loan facility from most banks. To me, they are an additional unnecessary expense.

It’s the banks wanting someone else to blame if things go wrong. Not all banks have a requirement for the trustees to get a sign-off from a financial adviser. But all that I’ve come across generally require one or more professionals (lawyers, accountants, financial advisers) to sign off on it.

Why does it cost so much? There’s actually no requirement for it to cost a thing. However, this is a complex and relatively new area. If a financial adviser is putting his professional licence on the line – which he needs to consider when he’s signing one of these – he’s unlikely to do it without making sure that the trustees are aware of the investment, tax and legal risks they face with a geared investment in super. The problem is that if the investment went pear-shaped and the bank was looking to disperse or share the blame around, they would come after the adviser. If the adviser couldn’t show they had provided reasonable advice (which may include providing a Statement of Advice), then they could face trouble themselves.

Blame the banks, not the advice community. Not all banks require it. Those that do are trying to do two things. One, to make sure that the clients have had some advice on the investment risks. Two, to cover their own butts.

We want to buy vacant rural land that we will be retiring to. Our reading of the SMSF legislation is that we cannot build on it as this will “change the nature of the asset”. Is there any way around this so we can build during the time leading up to retirement?

I assume that you wish to purchase this asset inside your SMSF, which is unstated. If there is no gearing involved, then you can make improvements to the property.

I understand there is a lot of confusion around this issue, but if the fund is using SMSF cash to purchase the land, and then SMSF cash to improve the property, then that is generally going to be okay. Every situation is different, so please seek tailored advice.

If residential property is all above board in a SMSF can it be transferred out at retirement for us to live in? What are the basics on this?

If you subsequently want to live in a property after you have retired and the fund is in pension mode, then you will need to make a lump sum payment from your super fund in the form of the property.

Thanks again for the great response to the webcast.

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, a licensed mortgage broker with Castellan Lending, and the author of Debt Man Walking. E: bruce@castellanfinancial.com.au

• Prime Minister Julia Gillard has refused to rule out the possibility that “wealthy” people's superannuation tax concessions could be hit in the upcoming May budget. There has been much talk in recent weeks that the federal government could reduce tax concessions for wealthier Australians to help fund the Gonski reforms and the National Disability Insurance Scheme. In an interview, Gillard said the federal government was focused on ensuring the superannuation system worked well and was sustainable in the long term. She also said that when she thinks of super, she thinks of “the interests of working people, what is in the interest of their decent retirement incomes, and what is in the interest of making the system sustainable.” But Labor Party politician and former chief whip Joel Fitzgibbon is concerned at what level Labor may deem Australians to be “wealthy”. “In Sydney's west you can be on a quarter of a million dollars family income a year and you're still struggling,” Mr Fitzgibbon reportedly said in an interview. Fitzgibbon isn’t the only one voicing his concerns. Former minister for regional Australia, Simon Crean, also recently commented on the speculation surrounding raising taxes on super, saying it would tarnish Labor’s legacy. “You can’t be taxing people’s surpluses built up in a super fund to pay for our surplus,’’ he reportedly said.
• Changes to the legislation around related party transactions for self-managed superannuation funds (SMSF) could have serious consequences for SMSF trustees who breach the rules unintentionally, according to SMSF Professionals' Association (SPAA) technical director Peter Burgess. The legislation, expected to take effect on July 1, changes the requirement from ‘must not intentionally acquire an asset from a related party of the fund’ to ‘must not acquire an asset from a related party’. “Removing the word ‘intentionally’ may have important implications for SMSF trustees who may be considered to have breached the related party asset rules even though it was unintentional, especially as new administrative and civil penalties will apply under this legislation,” Burgess said.
• Research from Deloitte Actuaries and Consultants has revealed that the SMSF sector is still enjoying strong growth and that SMSF assets should exceed $500 billion by the end of the financial year. Deloitte superannuation lead partner Russell Mason also said that the sector should reach the one million member mark by the end of the calendar year.
• AustralianSuper and Hostplus have announced they will soon launch “direct investment platforms” that are similar to the SMSF model in a bid to retain members who are considering leaving industry super funds. According to Hostplus executive manager of Member Choice and Advice, Paul Watson, 70% of members are thinking of leaving their super fund to set up an SMSF before retirement.