Recent changes to superannuation legislation now allow an SMSF to borrow funds for property investment. If you have an existing SMSF, you may now be able to borrow money to buy a commercial or residential property through your SMSF.
Limited recourse SMSF borrowing arrangement
If the SMSF has sufficient funds to put down a deposit, the remainder of the purchase price can be borrowed. The SMSF can borrow either from a financial institution (a bank or a credit union for example), or from the Fund’s Members.
Loans are set up with non-recourse borrowing arrangements. This means the lender has no right of recourse on any other assets in the SMSF. For this reason, the lender (the bank) will ask the Members for a guarantee. This arrangement is generally referred to as a limited recourse borrowing arrangement.
The SMSF provides the funds for a partial payment on the property and pays all the relevant fees. The SMSF will borrow to settle the balance.
If the SMSF pays a larger deposit on the investment property, the bank may waive its requirement for security from the Trustees. The property will be the sole security for the loan under this limited recourse loan agreement. In the event of default, the lender only has the right of recourse on the property; there is no right of recourse on other assets held in the SMSF.
As a general rule-of-thumb, if the bank is lending 80% of a residential property’s value, it will ask the trustees for a guarantee. The bank will not normally ask for a guarantee when the loan-to-value rate is 60%. For commercial property, these percentages are 70% and 50% respectively. In assessing the need for a guarantee, the bank will take into account the condition of the property, the credit history of the borrower, and the expected income from rental.
The investment property is owned by the bare trust with the SMSF having an entitlement to it as a beneficiary. The bare trust is merely the title holder until the loan is paid off. The SMSF will receive lease payments from the lessee and will expense the interest paid on the SMSF loan.
After the loan is repaid, the SMSF has the right – but not the obligation – to acquire the legal ownership of the investment property.
When purchasing a residential property, the SMSF is forbidden from having any dealings with a related party. This means that members of the Fund cannot sell their own houses to the SMSF. The Fund is also forbidden from renting the property to a Trustee, a family member, or a parent-in-law. Trustees can, however, purchase the property from the SMSF when entering the pension phase.
Benefits of purchasing property in your SMSF
- commercial property owned by you can be sold by the SMSF at market rates;
- assets in the SMSF are secure because the lender only has the right of recourse on the investment property, plus any additional security provided by the guarantor;
- the loan is repaid using super contributions and rental income;
- the SMSF is only taxed at the net income after loan interest and expenses have been deducted against the rental income;
- the SMSF is only taxed at a rate of 15% compared to marginal rates if the property was purchased in a personal capacity; and
- capital gains will only be taxed at a rate of between 0% – 15%.
Things to consider
- the SMSF must be set up before the bare trust and corporate trustee can be established;
- the bare trust and corporate trustee are mere title holders of the property and all transactions will occur within the SMSF;
- the trust deed provided by Superannuation Warehouse will allow for borrowing;
- the investment strategy of the SMSF should include provision for property investment;
- the SMSF will require sufficient cash flows to service the loan. This can come from rental incomes, investment earnings and members’ contributions;
- all transactions must be carried out at arm’s length and at market rates; and
- buying a holiday property in your SMSF and then using it for yourself is strictly forbidden.
All investment purchases should pass the sole purpose test.
Bank and Broker Information
You are free to use any bank or lender when arranging finance for your SMSF property purchase. To get the best deal possible, you’d be well advised to use a mortgage broker. You can use a big bank or one of the niche players like Macquarie who, by the way, have a very informative free brochure with some great examples. You can also download a cash flow analysis brochure here which gives examples on the cash flow details of an property with a limited recourse borrowing arrangement in place.
Trustees can contact Andrew Mackenzie from Sleep Tight Financial Solutions or Linda Mackenzie from Mackenzie Finance & Leasing Pty Ltd for more information. Their contact details are noted below:
Andrew Mackenzie (Director: Sleep Tight Financial Solutions)
p: 0414 741 330
Linda Mackenzie (Director: Mackenzie Finance & Leasing Pty Ltd)
p: 0408 456 267
ATO Guidance on Borrowing
The ATO’s ruling on borrowing can be viewed by clicking the link below.SMSFR 2012/1
The property details and other information we need from you before we can start setting up your Bare Trust can be found by clicking here.