Many people have decided to set up their self managed super fund over recent years because they like to have more control of their superannuation investments and in return, their super fund's growth.
One of the most preferred investments for an SMSF is residential or commercial property. The superannuation fund holds the title of any investment property if the property is purchased outright with only SMSF funds, or in a bare trust if the fund has borrowed money to buy the property.
But a question that many people ask is, 'can you buy a property to live in', with your SMSF? The short answer to this question is no, at least not until you retire.
There are very strict rules around what your SMSF can purchase as an investment property and how the property can be used. This is due to the rulings of the 'sole purpose test'.
If one of your resolutions is to plan for retirement, and eventually live in your SMSF property, be aware of the below significant hurdles. The laws around acquiring property with your SMSF aren't as clear cut as you may have thought. Although it's common knowledge that Australian law effectively prevents you from living in a property bought by your SMSF, there are examples of this occurring.
The answer depends on several factors, but it's best to wait until a legal document proves that the arrangement is allowed in order to avoid penalties and taxes. Simply reaching the preservation age or retiring does not unlock all the trustee's assets in the SMSF.
Consider the following SMSF property arrangements:
- The trustee owned the residential property prior to inclusion in the SMSF;
- The property was purchased through an SMSF loan;
- The SMSF asset is a commercial property.
One of the unique characteristics of self-managed superannuation funds (SMSFs), which make them attractive to some investors, is their ability to invest in direct property. A significant number of SMSFs do invest in direct property, and statistics from Class Limited showed this to be as high as 27.1% in 2016. This includes both residential and non-residential (i.e. commercial property).
Of the SMSFs that do invest in property, approximately half of the fund is invested in that property – 47% for residential and 51% for non-residential.
However, the reality of investing in property is that it is quite complicated and should never be considered as an easy way to enter the property market.
Having an SMSF is usually all about having greater control over your super, but with this comes a serious set of responsibilities and obligations, along with the requirement to exercise self-control. These attributes are even more important should you consider purchasing a property through your SMSF.
One very strict rule that is commonly misunderstood or not known is that if you are purchasing a residential property through your SMSF, you can't live in it and neither can anyone related to you, even if they pay market-based rent.
Further to this, if you already own a residential property, your SMSF cannot purchase this from you - again, even at market price. If you feel you may be tempted to utilise said property, or need to purchase an investment property for a family to live in - don't use an SMSF.
Commercial/business premises, however, can be leased to you or a third party related to you, providing this is done on a commercial arms-length basis. This is a particularly attractive proposition to small business owners. Your SMSF can purchase a business premises from which you can conduct your business, and pay rent to the super fund.
Many small business people don't pay themselves super, so paying rent that would otherwise go into someone else's pocket into the super fund for their retirement makes a lot of sense.
You may already own the building you run your business from. Subject to contribution caps and considering stamp duty and capital gains tax personally, you can contribute the premises to an SMSF, providing it is done at market value.
You need to have a decent balance already in super to make setting up an SMSF to buy property a viable proposition. This is very important should you need to obtain finance to complete the purchase.
Why? Banks will require an SMSF to have at least 40% of the value of the property as a deposit, will most likely charge a higher rate of interest and will not entertain approving finance for a fund that doesn't have at least $200,000 initially, and decent liquidity (cash and/or shares) in the fund post property purchase.
This is due to the requirement that an SMSF can only borrow via a limited recourse borrowing arrangement (LRBA).
You need to consider whether the fund can cover ongoing property ownership costs should the property be vacant for a period and there is no rental income.
Similarly, if the meeting of mortgage payments is reliant on super guarantee contributions - what happens if one or all the members of the super fund become unemployed?
A residential property that is personally owned can be transferred into an SMSF if so desired as long as the trustees can prove it is being used for business purposes and not merely as a rent-generating investment, a financial services law firm has stated.
Townsends Business & Corporate Lawyers said the issue of whether or not a property could be considered 'business real property', and therefore eligible for inclusion in an SMSF, was a common issue for fund members looking to transfer a property into their fund.
"While the term 'business real property' seems to suggest that a property has to be a commercial property (or other non-residential property) to qualify as such, this isn't always the case," the legal firm said in a blog post on its website.
Transferring a commercial property into an SMSF can be a great way to build retirement savings and take advantage of the concessionally taxed SMSF environment. But when acquiring property from a related party, it's vital the property meets the "business real property" test. Make sure you know the essential elements of this test when exploring this strategy.
Holding property in an SMSF can certainly have tax advantages. The rental income and capital gains are concessionally taxed, or even tax exempt to the extent the property supports retirement phase pensions. So, suppose you run a business and own your business premises, or are simply an investor with a commercial property. In that case, you may have thought about transferring the property into your SMSF.
The general rule is that SMSFs aren't permitted to acquire assets from a related party of the fund (which includes the members, their relatives and related trusts and companies). However, there are a few limited exceptions, including "business real property" (BRP) acquired by the SMSF at market value. This is the only type of real estate that an SMSF may acquire from a related party.
The Sole Purpose Test
It all centres around the sole purpose test - the idea that superannuation money must be maintained for the sole purpose of providing a benefit to members in retirement, or in the event of disability or death. This essentially means that you can't invest super money into something that will give you a benefit before retirement.
The trustee's intention is key. Using super money to buy artwork, for example, is legal under the category of collectibles, but only if the person is doing that to make money for retirement (i.e. they're not deriving any personal use of the asset before retirement).
The sole purpose test states that your SMSF "needs to be maintained for the sole purpose of providing retirement benefits to" 1 its members or the dependants of its members, in the case a member dies before retirement.
What this is saying is that you or any member of your family many not obtain a financial benefit from any assets that your SMSF has purchased, prior to the superannuation fund members' retirement. This includes property, artwork or other collectibles and even holiday homes.
Any assets in your SMSF are therefore preserved until retirement just as would be the case with an industry or other private superannuation fund scheme. In fact, there are very serious consequences if the sole purpose test is violated, such as criminal and/or civil penalties.
Further information about the sole purpose test can be found on the Australian Taxation office website where you can download a PDF version of the ruling.
However, this situation changes when you retire. You can perform what is known as an 'in-specie' transfer of your SMSF's assets to you in their current form, rather than by converting them to cash. But you do still need to consider stamp duty, which is payable on the transfer out of the SMSF into your name.
Technically you can:
- Acquire a property in super during your working life.
- Benefit from concessional tax rates on rental income.
- Make pre and post-tax contributions up to your caps to pay down any relevant loans.
- Then transfer the property out when you retire.
But, there is a high likelihood that the ATO will take a sceptical view and enquire as to whether there has been a breach of the sole purpose test.
The problem is that an investment property in an SMSF should only have been acquired if it was a good investment for the fund and in line with its properly formulated investment strategy. It should not be acquired with the intention that it will be the retirement residence for one of the members or their relatives. If the property is to be paid out in-specie to a member in retirement, although still within the law, it should only be done if it is logical or the only possible action for the fund, to reduce the chances of breaching the sole purpose test.
You Can Purchase A Retirement Home With Your SMSF
While you can't purchase a property to live in with your SMSF while you're still working, you can however purchase a home which you can live in when you are fully retired.
This means that your SMSF can purchase an investment property, which you'd eventually like to live in and rent it out until you retire. It must be noted though, that the property needs to be rented to a totally unrelated third party at market value and cannot be rented to family members or friends.
In this instance, your SMSF or a separate bare trust will hold ownership of the property until your retirement. This means that all rents received will be deposited into the SMSF as income and the fund is also responsible for paying all property maintenance costs as well as property management fees and other expenses.
Once you retire and start receiving regular retirement income from your SMSF you can sell your existing family home, which you are currently living in, and put the proceeds into your SMSF. This is regarded as a contribution to your fund and will ,of course, be subject to any contribution caps that apply to your own personal situation.
After this has been done, you can then transfer the title of your investment property from your SMSF into your own name. This effectively means that you are purchasing your retirement property from your superannuation fund.
So if you've always dreamed of retiring to a lovely coastal home or a spacious city apartment, you can now afford to do so by using the investment funds in your SMSF.
Can I Use My Superannuation To Buy A House To Live In?
This is a question asked by many Australians time and time again.
We're often told that superannuation is our money, so we should be able to use it how we please, shouldn't we?
Housing affordability in 2020 makes it difficult to enter the property market. But with superannuation savings ever-increasing, surely this would be the most logical way to get a foot in the door.
However, despite superannuation being your money, there are certain rules around accessing your super, which may prevent you from using your superannuation to buy a house to live in.
You may be able to use your superannuation to buy a house to live, but certain conditions must be met first.
Generally, in order to use you super to buy a house, you must meet a full superannuation condition of release.
The most common conditions of release are 'retirement 'or reaching age 65.
Retirement is defined as retiring after reaching your preservation age with no intention of returning to work, or having an employment condition come to an end after age 60.
If you have met the definition of retirement or attained age 65, you will have full unrestricted access to your superannuation savings.
However, in order to use these superannuation savings to buy a house to live in, you would first need to withdrawal from super the amount you require to buy the house and direct the withdrawal to your personal bank account.
This amount could then be used towards the purchase of a house to live in.
Just make sure you understand any potential tax implications of making a withdrawal from super.
In no circumstance are you able to buy a house to live in while the money is still within your super account.
You may have heard about people using their superannuation to buy a house or other property within a self managed superannuation fund (SMSF).
While this is possible in some circumstances, it must be for investment purposes only under an arm' s-length arrangement.
What Are The Risks Of Investing In Property Through My Smsf?
Property investment using an SMSF will not make it immune to any of the usual risks involved in property investment. There are some issues, however, that are unique to holding property in an SMSF and they are outlined as follows.
Property is a lumpy, relatively illiquid asset. It can take time to sell and settle and you aren't able to sell a part of it - it's all or nothing.
Once members move into retirement phase there must be a minimum drawdown from the fund each year to maintain the funds' tax-exempt status. If the property isn't positively geared, and the fund only holds the property and little cash, it is difficult to meet these requirements.
It proves a difficult asset to hold when the focus of the fund moves from the building of wealth for retirement, to being in retirement and needing to draw a regular income stream.
The usual strategy is to sell the property when members reach retirement to have sufficient
liquidity to pay the appropriate income streams. The timing of this may not be ideal if the property hasn't been held for sufficient time or there is still a decent mortgage over the property. These scenarios need to be worked through as part of the fund's long-term investment strategy.
Properties have ongoing costs and without sufficient contributions to the fund and rental income these become difficult to finance within the fund. As well as regular ongoing costs, there may be large unexpected costs that will also need to be financed. You may need to find personal monies to cover these costs, and they can't be paid back by the fund.
You need to consider the impact that purchasing property within an SMSF will have on your non-superannuation monies.
The superannuation space continues to be subject to legislative changes. It is not known whether future changes may impact negatively on those who hold property within an SMSF.
If the property investment requires finance, the additional requirements involved because it is being purchased in an SMSF are both more expensive and complicated. Failure to understand these complexities or engage appropriate professionals who know how to navigate the space can result in further unnecessary costs and potential loss of your retirement savings.
Additional stamp duty is a big danger if a property purchased via an LRBA for an SMSF is not executed correctly.
If you don't already have an SMSF but want to establish one to purchase property and you require finance, it is strongly recommended you gain pre-approval first.
If you set up an SMSF then seek finance, you may be disappointed to find that you are unable to gain sufficient finance for your proposed plan and you are left with having to pay for the establishment of the fund and the ongoing compliance obligations that come with it. It's a much harder set of rules and obligations that need to be met by the SMSF than if you were to do the same personally.
The temptation! If you have purchased a residential property or holiday home through your SMSF, you must resist the temptation to use it personally or let anyone related to you do so. Doing so risks the complying status of your super fund and, in the worst-case scenario, the loss of the majority of your super in tax and fines.