By Andrew Hayes, Director, Westlawn Business Services 16 October 2013
Recently, there’s been some media focus on the risks associated with investing in geared property through self managed super funds (SMSFs) and whether it’s really the right long-term decision for a member’s retirement. It can be the right choice for some, but it’s not for everyone. Opportunities come with risks which are the same as any individual’s decision to make a personal property investment. There are, however, some risks which are unique to SMSFs.
While property can reward investors with steady rental income and capital growth over the longer term, when it comes to property and SMSFs, the investment needs to be carefully considered. This applies especially where borrowing is involved, due to the potential demand on the fund’s cash flow that is provided by a steady stream of contributions. In hard times, if the property cannot be leased, the cash flow from contributions may be needed to pay investment expenses.
The advantage of investing in property in an SMSF is the generous tax concessions available through super. Rent will be taxed at 15% and capital gains from selling the property can be as low as 10% while saving for retirement. If you’re taking a pension from your SMSF, any rent and capital gains may be tax-free. Because of these low tax rates, however, the benefits of negatively gearing an investment property can be less than if you did this as a personal property investment.
Also, whether a large illiquid asset like property will suit the SMSF member’s retirement needs must be considered. Selling an illiquid asset like a property can take time and involve higher costs than selling more liquid assets such as ASX-listed shares, which can normally be sold quickly. The sale of the property may also result in a large sudden inflow of funds which will need to be managed carefully if the SMSF is to pay a pension.
Borrowing to invest in property
An SMSF can invest in residential and commercial property either directly if it is ungeared or by using a limited recourse borrowing arrangement (LRBA) where the fund borrows to purchase a property held in trust on behalf of the SMSF.
These arrangements involve complex rules and structures and require extensive legal documentation and bank loan approvals.
LRBAs essentially limit a lender’s rights against the borrower to the property that secures the loan. This means if an SMSF borrows to buy a property via an LRBA and the SMSF is unable to repay the loan, the lender can only seek compensation by taking possession of the property alone. The lender cannot access any of the fund’s other investments.
The LRBA rules also limit the types of properties that can be acquired and what can be done to the property. Properties need to be single investments and complex rules apply to how repairs and improvements can be made to the property.
Disclaimer Westlawn Business Services Pty Ltd provides this information for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers.
Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation.