A lot of people have used their superannuation fund to buy a property. And on the face of it; it is a great idea. The ability to borrow money in a SMSF together with the tax advantages that superannuation funds have on offer make it look like that it is a match made in heaven.
However buying Perth land in a superannuation fund is not without tax drawbacks. So we have attached a few more of the tax and financial angles you should consider about using your SMSF nest-egg to buy a home.
Sadly investment promotors are still permitted to enjoy commissions for the sale of residential real estate to a superannuation fund. So if anybody is looking at buying a property in their SMSF we always recommend that a second opinion from an ASIC licensed financial product advisor is obtained. And we have some great financial product advisors who are part of our Westcourt FBA collaborative network.
And no – the advisors we recommend do not pay us a spotters fee either (goes without saying really).
You can’t live in it (but maybe you can?)
A superannuation fund can have one purpose only – to provide for your retirement. So even if you would be the best tenant in the world as a tenant your superannuation fund will breach the sole purpose test.
Why? Your superannuation fund will also be giving you stable tenure on your home. So the provision of a family home from your superannuation fund to you (in the form of a market lease) fails the “sole purpose” test.
So the short answer is that you cannot buy your first home in your superannuation fund and live in it.
And there is always a loophole. Smart property tax accountants will look for a loophole.. The exemption of course is for commercial property owners. Your SMSF can own commercial real estate that is then leased to a member (or somebody associated with the member). Not exciting you say? Well if the superannuation fund buys a farm, and the accommodation on the farm is of a minor and and ancillary nature then a superannuation fund can lease the house to the member (Self Managed Super Fund Ruling 2009/1)
The Harrison Family buy a vineyard. It is owned and managed by Peter and Denis Harrison.
The property has 10 hectares plated with vines and a house with half a hectare.
The vineyard business has a supply agreement to provide grapes to the winery next door for the next 5 years.
The SMSF buys all of the property (including the private home) from the Harrison Family. The SMSF then charges a market value rent to Peter and Denise for the use of the farm and house.
The use of the home rented to Peter and Denise is permitted under the “wholly and exclusively” test under subsection 66(6).
The tax advisory needed in this instance is complex. And it is significant as a breach of the associated laws can mean that the superannuation fund loses all of its tax concessions and the tax law applies a tax rate of 47% of the balance of the superannuation fund.
Buying your dream retirement home?
It is important to note that the sole purpose of the fund is to provide for your retirement. However when you are in retirement the superannuation fund can sell the home to the member for market value.
Once the member buys the home from the superannuation fund they can then live in it.
This is a potential strategy for somebody who say, identifies a “dream home” but simply cannot afford to live in it. The use of the superannuation funds, at a lower tax rate, effectively allows more of the capital to be repaid more quickly than what would otherwise occur if it was a straight purchase at a personal level.
Again, a tax strategy that can be used in different ways.
Borrowing money in your superannuation fund
The ability to borrow in your superannuation fund is now a well-established strategy. And a good finance broker (who is independent of the decision to buy) is ideally placed to let you know of the bank lending attitudes and the banks requirements for cash reserves as a minimum in a SMSF.
If you do borrow money the structuring of the companies, trusts and associated documentation to preserve the superannuation funds tax concessions is critical before you start the process. Getting the tax ready status of your superannuation fund, and the loan approval before you sign the contract is important. These things can take longer than expected.
If the home is negatively geared it is important to note that the tax benefit of the negative gearing is less in a superannuation fund.
Of course once you retire, and you have less than $1.6m, the fund can sell the home tax free.
Sometimes bank lending for a superannuation fund is higher. However the finance broker is also better placed to discuss the potentially higher borrowing costs in a superannuation fund.
Buying your first home?
From 1 July 2017 first home buyers can salary extra into the superannuation fund, enjoy the tax concessions, and then take this money out later on for a home deposit. It is refer to as the “First Home Super Saver Scheme”.
If you make additional contributions to your superannuation fund, you can enjoy tax concessional tax status of superannuation and then request your superannuation fund to release $15,000 of your FHSS contributions from any one year or $30,000 in total across all years.
We are not going to discuss this scheme in detail at this stage other to identify it as an option.
What if your super fund runs out of money?
It is important to remember that bad things happen to good people. People get sick, people lose their jobs, tenants wreck houses, houses go for a long term without a tenant and people get divorced.
If your superannuation fund is dependent on the rental income – and something bad happens – life becomes very difficult. The tax rules about the maximum you can inject into a superannuation fund are quite prescriptive and narrow.
Is diversification necessary?
The world has more investments available to it than residential property investment.
If your retirement plan is a one trick pony (Perth residential investment property) – you should consider the wisdom of that approach.
The downside of direct property investment is that it is very large. Most “mere mortals” do not have a superannuation fund large enough to invest directly in property and other types of assets and enjoy diversification.
In this instance other options should be investigated. You could look at property syndicates, property ETF’s covering commercial and international and property development businesses. All of these options give you exposure to property and do so for a lower entry point.
An investment advisor or real estate agent, who should be part of the Westcourt collaborative advisor network, can give you information about these type of investments and investment platforms as well.
Getting capital gains tax exemption on retirement
If your superannuation fund has less than $1.6m, retired and the superannuation fund is in pension phase, the profit on sale of a property in your superannuation fund can be tax free.
This is a simplified example and more is needed to consider the matter. However the key take-away is that the capital gain on the sale of a property in superannuation can be very attractive – and might overcome the reduced negative gearing benefit.
Financial modelling on buying a home
The purchase decision of a home is complex – especially due to the the size of the investment. And there are many operators out their providing advice on how to purchase a home and the financial impact to you on buying the home. Sadly the costs of this strategic advice is often enormous ($20k plus) with the net advice coming down to some simple financial modelling based on assumptions and forecasts.
At Westcourt we also offer a financial modelling and tax advice on structuring home purchases. However the costs of meeting with a partner for 3 hours, and a detailed report on the net after tax outcomes of your decision is $1,650 including GST. We can also refer you to licensed investment professional, and to a licensed life insurance broker, to compare your investment decision to other alternate investments, insurance policies, and other superannuation structures – like an industry superannuation fund.
Importantly we acknowledge that business families are active in property as an asset class. And we provide services to help those business families choose the best after tax outcomes of their decisions.