How to purchase property through your SMSF
by Chris Tetzner, Para-Planner
Utilising a warrant structure to purchase a property via a Self Managed Superannuation Fund
Until recently, Self Managed Superannuation Funds (SMSF) were not permitted to borrow to invest in direct property. This changed on 24 September 2007 when the Superannuation Industry Supervision Act 1993 (SIS) was amended. This allowed superannuation funds to borrow to invest in direct property via an instalment warrant, or a similarly structured and complying arrangement such as a bare trust. Today, we will concentrate on the warrant structure and how this might be used to purchase an investment property via your SMSF.
How does a property warrant work?
There are 3 main parties involved;
1. The Investor (SMSF)
2. The Security trustee, and
3. The Lender
Under this structure, the security trustee holds the property in trust for the beneficial owner, being the SMSF. The SMSF pays a first instalment, typically made up of the 20 per cent deposit plus the costs required to purchase the property.
The Lender provides the finance on a limited recourse basis, that is, in the event of a default the Lender only has a claim on the property held via the warrant. This protects the other assets of the SMSF. The net rental returns after property management costs, rates and other outgoings that have been deducted, are paid back to the SMSF via the security trustee. These returns are used to pay the ongoing interest costs on the loan. Any shortfall will need to be made up from other funds available in the SMSF or by making further contributions to the super fund.
Over a period of time, typically 10 years, the SMSF can make further instalments on an annual basis to reduce the loan until eventually, the loan is repaid in full. The Security Trustee will then transfer the ownership of the property to the SMSF without triggering any capital gains tax (CGT).
What are the benefits of purchasing a property via your SMSF using a warrant structure?
• Taxation – superannuation funds pay tax at 15 per cent in accumulation phase dropping to 0 per cent in pension phase. This can potentially result in large CGT savings, compared to being taxed at marginal tax rates up to 46.5 per cent if the property is personally held.
• Making concessional contributions to superannuation to fund any ongoing commitments, for example, the interest payments. These contributions come from pre-tax income and are taxed at only 15 per cent compared to up to 46.5 per cent if funded from after tax income. Care should be taken that you remain within the contribution caps, taking into account all types of concessional contributions, for example, superannuation guarantee contributions. The caps are currently $25,000 per annum if you are under age 50, and $50,000 over age 50.
• Potentially higher returns by gearing into an investment property using a warrant structure, without the risk of recourse on the other assets held in the SMSF.
What should you also be aware of when investing using a warrant structure via your SMSF?
The ATO issued a tax payer alert in 2008 – TA 2008/5 outlining some concerns they have with this particular structure, including:
• Purchasing the asset (investment property) from a related party. This is a breach of the SIS regulations which prohibits residential property from being purchased in this manner.
• Where the Lender requires a personal guarantee from the trustees/members of the SMSF. The ATO’s view is this may result in recourse being available on other assets of the SMSF, thereby negating the limited recourse nature of the original borrowings.
• If finance is secured from a related party, rather than a Lender at a zero interest rate or less than a commercial rate of interest, this could be characterised as a contribution rather than a loan, resulting in excess contributions tax at a rate of 46.5 per cent.
• If the finance is secured from a related party at greater than a commercial rate of interest, this also breaches the SIS act in that it may mean the SMSF is not being maintained solely for the purpose of providing superannuation benefits.
Investing in direct property within a SMSF can be daunting at first glance, but the benefits can be substantial for you. It is important that you meet with your Financial Adviser for more information to discuss your options.
For more information, or to arrange an appointment with a John Hopkins Financial Adviser, please contact our Client Liaison Officer on 1300 726 082 or click here.