Property investing for dummies: Lending lines for DIY funds

PORTFOLIO POINT: Adding a negatively geared property to your SMSF can provide an extremely low-tax environment, even for accumulation SMSFs.

As SMSF trustees, we pride ourselves on our thirst for knowledge. And that includes tax. Superannuation is, after all, a vehicle that is primarily about tax-effective saving and income streams, for your retirement.

That’s one of the reasons SMSF’s have always loved fully franked dividends. Receiving a $70 dividend from a company means you’re entitled to at least another $15, for a super fund in accumulation phase, but potentially another $30 for a fund in pension phase.

We can use those to balance, or offset, the contributions taxes we need to pay on our concessional contributions, or other earnings taxes we might have to pay. Tax can be effectively managed.

But geared property in SMSFs adds a big new dimension to tax in super funds. And, with an increasing belief that property has suffered the worst of its two-year gentle slide, more people are taking a look at the potential benefits of a super fund with a geared property.

In fact, they’re jumping on board and are happy to do so with an element of gearing. Figures from SMSF services provider Multiport said that 29% of all direct property holdings in its survey had a “limited recourse borrowing arrangement” (LRBA) in place. This was up from just 24% for the previous quarter, suggesting that the overwhelming majority of direct properties purchased in that December quarter were purchased using an LRBA.


What more SMSF trustees are waking up to is the effect that negative gearing has on the overall taxation of the fund. A negatively geared property can have the following benefits to a super fund:

  • Wipe out income tax on investments
  • Wipe out contribution tax (also income tax)
  • Get back all, not just part, of franking credits.
  • Save up income losses for future years when concessional contributions might be higher.

In fact, your super fund can get itself into the position where it pays no tax inside the fund now. Not when you finally turn on a pension, but now.

How? Well, let’s run through an example.

I’m going to start with a geared property along these lines. The property is purchased for $500,000. The loan is for 80% of the fund, or $400,000. The interest rate is 7% and it’s interest only. (I realise that’s considerably higher than current interest rates, but I’m deliberately trying to use a longer-term average.)

Rent is a constant 4% of the value of the property, where the property is increasing at 5% per annum. Total return, therefore, is a constant 9%. CPI, as it relates to the costs of the property (agent’s fees, rates, insurance and general maintenance) is 4%. I’ve also assumed the property was built about 10 years ago, so there is some depreciation both for the building and fixtures and fittings ($6000 a year).

To purchase the property, the SMSF would need to have put up around $130,000 for the $100,000 deposit, plus stamp duties and other costs.

Using that as a scenario, the property is negatively geared, for its first full year of ownership at $20,000. That means there is $20,000 worth of income to the remainder of the super fund that can be sucked up before any further income tax needs to be paid.

That could be $5000 worth of earnings on other investments and $15,000 worth of contributions. Even if there are two members putting in up to their concessional contributions limits of $25,000 each, the trustees at least would have saved themselves around $3000 in contributions taxes on that first $20,000 of income from the negatively geared property.

Larger funds, of course, could potentially do multiple investment properties. There’s no limit to the amount of borrowing a super fund can do. Banks will limit what they, individually, will lend to the fund. But the law doesn’t state how much borrowing a fund could do.

(Literally, if James Packer wanted to lend his SMSF $50 million for a property investment, he could. If 10 years down the track, the properties had grown in value to $100 million, and he repaid the loan, then he’s created a $50 million fund.)

Sure, it’s a few thousand dollars here and a few thousand dollars there. But by building a model based on the above, the cumulative negative gearing tax losses from the property to year 16 total a little more than $203,000 – there’s more than $30,000 in tax that’s been saved in the meantime. At that point (year 16), the property has become positive geared and there will be tax to pay.

But by that time, possibly before, you might be ready to add a second, or a third LRBA property to your fund.

But it can go much further than that

Above, I have used a loan-to-valuation ratio of 80%. That’s the maximum lenders will go to under LRBAs because of the “limited recourse” nature of the loan. (Some won’t even go that far.)

But if you, as an individual, are prepared to be the lender to your SMSF (generally by borrowing against other personally owned non-super property to loan into the SMSF), then you go further than that. See this article (21/4/10) for a more in-depth explanation of you becoming the lender to your SMSF.

By doing that, you can potentially lender yourself the full 106% of the value of the property (ie, the total cost, plus stamp duties and legals).

Risks of gearing

The potential benefits of leveraging are reasonably well known and the principles, whether inside or outside super, are relatively similar. Gearing will magnify the returns (both up and down).

In the example used above, the property, in year 16, when the negative gearing turns to positive gearing, is worth a little more than $1.09 million (assuming that growth rate of 5%).

But negative gearing only works if the property increases in value. It rarely makes sense otherwise. If property goes into a long funk, then geared strategies are potentially disastrous.


The information contained in this column should be treated as general advice only. It has not taken anyone’s specific circumstances into account. If you are considering a strategy such as those mentioned here, you are strongly advised to consult your adviser/s, as some of the strategies used in these columns are extremely complex and require high-level technical compliance.

Bruce Brammall is director of Castellan Financial Consulting and the author of Debt Man Walking. E: