(03) 9020 2905SUMMARY: If you’re comfortable with property outside super, why wouldn’t you invest in property inside your SMSF?
The power of property investment is a broadly understood wealth-creation concept by those Australians who have been doing it for a long time.
Australians are increasingly getting used to building property portfolios, and are at ease with the debt that almost always comes with that burgeoning asset base.
While there are many property strategies, the most common is roughly this: Buy a quality asset (usually geared) and hold on to it for a long time (usually forever) to allow the power of compounding to work its (usual) magic.
Over time, the income from the asset increases. This will, depending on the level of gearing, normally turn a negatively geared investment into a positively geared one over the course of years. As the equity and income grows, the portfolio can be expanded.
The coveted prize is most often capital growth. If you buy an asset for $500,000 and it appreciates at 5% a year for the next 20 years, you’ve got an asset worth $1.32 million.
Are you already a property investor? Is that the rough plan you’ve been following?
If yes, why wouldn’t you recreate the same strategy in a SMSF?
I’ve heard a lot of property investors give a lot of different reasons as to why they wouldn’t do it in super. The main one being that it’s “too risky”.
That has always struck me as a little bizarre. Property investment inside super is really no more risky than outside super, as an investment asset. There are differences, sure. And I’ve been through those in columns including 16/12/13.
The biggest difference when it comes to risk is “legislative risk”. But there is no current signal that governments are going to change the rules as they relate to property investment in super. If the government is reviewing the rules, then it is in secret – they have not asked for public submissions. (And even if they did change the rules, they would most likely grandfather those already invested.)
Why property investment works in SMSFs
If property investment is your thing and the length of time required to make property work is pivotal to your understanding of what makes property work, then property can actually make more sense inside a SMSF than outside.
Why?
Because of the way super is taxed.
In the early years, properties tend to be negatively geared. The advantage here is in the favour of non-super property investment, because tax rates outside super tend to be higher.
However, a negatively geared super property has the ability to turn your SMSF into effectively a tax-free zone right now. (See my column of 20/10/10.)
Negative gearing in a super fund can soak up income from the remainder of the fund. For example: If a property is negatively geared to the tune of $20,000 and the fund has other income of $25,000 from contributions and another $5000 from other investments, then the fund will only pay tax on $10,000 of income, effectively soaking up the majority of the contribution tax that would have otherwise been paid, rather than the entire $30,000 of income.
SMSF properties real benefits
The real benefits come at the other end. Particularly when the super fund is turned into a pension fund.
If a property bought outside super at age 50 has become a positively geared property for the investor at age 60, then there will be tax to be paid on the income.
And if the investor wants to sell one (or more properties) later in life, it will be impossible to escape a big capital gains tax bill. Even if no other income is earned during the course of a year, a capital gain of $200,000 on a property is going to cause a CGT headache.
This can often be the biggest problem for individuals with property – the CGT at the end (if you ever sell). If you don’t ever sell, there is no CGT issue. Or, you’re simply leaving it for the next generation to pay.
But the property in super?
Turn on a pension and, if you were paying any tax in your SMSF, there will now be no tax to pay. No tax on any positively geared income. No CGT if you want to sell.
Super pays no tax after a pension has been turned on.
Property – the end game
It’s the end game that should make property in super so appealing to SMSF trustees that have long been lovers of property outside of super.
Tax-free rental income is pretty sweet. But the ability to sell and pay no tax is the icing on the cake. (Capital gains are wonderful, but it can often be hard to sell if a giant tax bill is taken into consideration.)
Property in super, when in pension phase, eliminates that problem for SMSF trustees.
To a degree, property inside or outside of super is a trade-off. The tax deductions outside of super are bigger. The possibility of zero-tax during the end game in super will make up for part of that.
But it’s really not a trade off. You have to have super. You have to have it invested. And for those who have long been property investors … well, it’s a surprise, to a degree, that so few have taken up the option of investing in property.
Property is not for all SMSF trustees
Don’t make a geared property in your SMSF your first property investment. Property investment is a much more hands-in investment than shares. The level of gearing is higher.
The required knowledge is greater than shares.
Too many people get property wrong and/or get sucked into property when they don’t really know what they’re doing. ASIC have long raised their concerns about the number of new SMSF trustees who purchase properties from spruikers and has an eagle eye on that sector of the industry.
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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, plus four titles on property investment, including Property Investing For Dummies (John Wiley & Sons, 2013). E: bruce@castellanfinancial.com.au