The 5 Self Managed Super Funds Property Investment Rules You Need to Know
Using self-managed superannuation funds (SMSFs) has become an increasingly popular way for Australians to invest in property.
The number of SMSFs has continued to rise in recent years, along with individual member and overall fund balances.
According to the Australian Taxation Office (ATO), there were 593,00 SMSFs reported in June 2020, with an average of over $1.3 million in assets per self-managed super fund.
There are a few significant benefits to SMSF property investments, including only paying 15% tax on net rental income.
However, the ATO firmly regulates how an SMSF can be used as an investment vehicle. So, here are five self-managed super funds property rules that you need to know before opting for this investment strategy.
1. Self Managed Super Fund Compliance Laws
While SMSF trustees have the power to control the decisions made about investment strategies, these decisions must abide by all the legal compliance rules.
Self-managed super funds differ from ordinary superannuation funds in that they’re regulated by the ATO, not by the Australian Prudential Regulation Authority (APRA).
The most important consideration of all SMSF investment strategies is that they must satisfy the sole purpose test. The sole purpose test requires that the SMSF be set up for solely providing retirement benefits.
Beyond satisfying the sole purpose test, the trust deed and trustee’s need to:
- establish an investment strategy and make their investment decisions in accordance with that strategy,
- take out appropriate insurance cover for each SMSF member to protect them against investment risk,
- only accept member contributions into the SMSF,
- monitor the total SMSF balance and transfer balance cap,
- appoint a registered auditor to complete the annual audit,
- maintain the relevant administration documentation for record-keeping purposes,
- ensure that each member has met the conditions of release before they withdraw funds from their SMSF, and
- lodge the SMSFs yearly tax return with the ATO.
If members fail to comply with the sole purpose test and other legal requirements, the ATO is authorised to impose various penalties.
2. You Can’t Buy Residential Property From a Related Party
Apart from complying with SMSF compliance laws, the ATO proposes strict guidelines that govern what property you can purchase and from whom.
To comply with these strict guidelines, the investment property must:
- not be purchased from any fund members or member relatives;
- not be a place of residence for fund members or related parties; and
- not be a rented residence for fund members or related parties.
Chloe and Mitch have recently set up an SMSF and would like to use it to purchase a residential investment property.
Chloe’s sister, Amy, is currently selling her apartment in Brisbane. It’s in a prime location, and it would make a great investment property.
So, Chloe and Mitch look into buying the property from Amy.
However, after consulting with their financial advisor, they were informed that they aren’t allowed to buy property from Amy because buying a relative’s residential property violates SMSF compliance rules.
3. Compliance Rules Differ Between a Residential and Commercial Investment Property
While the SMSF compliance guidelines apply to purchasing property, whether it’s residential or commercial property, there is a degree of flexibility in how you use your self-managed super fund commercial property.
For example, suppose you’re a member of an SMSF. In that case, you can use the self-managed super fund to invest in your business premises, as long as the commercial property is primarily used to carry out your business activities.
However, it’s worth noting that an SMSF is not allowed to invest in your actual business.
So, your business will become the tenant of the office space that the SMSF owns. The commercial rent you pay for the business premises will go directly into your SMSF – you’re paying rent, but it’s benefiting your superannuation fund.
4. SMSF Rules When You Borrow Money
While SMSF regulations allow you to take out a home loan for your property purchase, there are, once again, self-managed super funds property investment rules that govern the process.
To borrow money for your self-managed superannuation fund property, you need to establish a limited recourse borrowing arrangement (LRBA).
The limited recourse borrowing arrangement requires that you set up a separate trust to protect the other assets in the SMSF.
The separate trust holds the property investment outside of the SMSF structure. Although all the investment property’s income and expenses will still go through the superfund’s bank account, the property itself is just held on the SMSFs behalf, in another trust structure.
Suppose the SMSF defaults on the loan repayments. In that case, the lender is only authorised to take back the separate property trust and nothing else held by the SMSF because of the limited recourse borrowing arrangement.
5. SMSF Taxation Rules
One of the most common reasons investors end up using their SMSF to buy property is the beneficial tax rules:
- The marginal tax rate for investment income is 15%
- Rental income that the fund receives once you’ve reached the pension stage and can access your retirement savings is tax-free – so eventually, you won’t have to pay tax on your rental income.
- Investment properties held in the super fund for longer than 12 months qualify for a capital gains tax (CGT) discount on SMSF property sales, and your capital gains tax liability will only be 10%.
- Interest on the SMSF investment property loan is tax-deductible.
The ability to control investment strategies and buy investment property using a self-managed super fund is an attractive option for many property investors – not to mention the beneficial reduced tax rate for high-income earners.
However, the ATO has implemented various strict guidelines based on protecting your financial and retirement interests vested in the SMSF.
Your investment decisions must be in accordance with your investment strategy founded on the sole purpose test. Any decision you make must be made solely for retirement benefits in mind.
Because there are various complex compliance regulations, you should consult with a financial advisor before you venture into SMSF property Investing. And once you’ve gone ahead with your investment strategy, we suggest that you also consult a tax specialist to help you make the most of those tax benefits available to you.
At Property Tax Specialists, our primary focus is helping property investors maximise their opportunities and protection while legally minimising their tax liabilities.
To discuss any matter relating to self-managed super funds property investment rules and arrange your affairs for minimum tax, get in touch today.
DISCLAIMER: This information has been prepared without taking into account your objectives, financial situation or needs. Because of this, you should, before acting on this information, consider its appropriateness, having regard to your objectives, financial situation or needs.
Amir Ishak is a Limited Authorised Representative 1269908 of Merit Wealth Pty Ltd, Australian Financial Services Licence 409361, ABN 89 125 557 002