(03) 9020 2905PORTFOLIO POINT: The Tax Office has put some meat on the bones of “repair” and “improvement” versus “new asset” regulations for geared property in super. And the news is good.
There’s something in the air. And it looks like it might be contagious.
While one swallow (even two) doesn’t make a spring, there’s a pattern emerging. Hope it’s not bird flu.
It appears that common sense is breaking out on several super fronts. A few weeks ago, it was Bill Shorten and the Future of Financial Advice reforms. And now, the Tax Office has cleared the air on what can be done to property in super gearing arrangements. Specifically, what constitutes an “improvement” to an asset, versus what creates a “new” asset, which has caused a lot of confusion since the super property gearing rules were introduced in 2007 and amended in 2010.
(We can only hope that the Gillard Government will make it three from three in the coming weeks in regards to a review of concessional contributions in super.)
In essence, the ATO’s announcement concerns what you can and can’t do to a property inside super that has borrowings against it (known as a limited recourse borrowing arrangement, or LRBA), or that will have borrowings against it.
To be more precise, a concern has long surrounded what improvements could be made to a geared property in a SMSF. The rules seemed to be overly strict – you couldn’t improve the property. And only limited restoration work could be undertaken. In some quarters, the fear was that even updating a kitchen that was almost “unrentable” could land you in trouble with the ATO, as you might have made an improvement to your property.
Even “maintaining” a property – that is, your guttering falls off and you want to replace it – was questionable. If the old guttering was so old that it was about to fall off anyway, would replacing it with new guttering be considered an improvement? Possibly not, but the rules weren’t clear.
The worst case scenario for SMSF geared property investors? Something like the property burning down and not being able to rebuild, because that could have been construed as an improvement of the original property, particularly if the original building was run down.
And that, obviously, is totally ridiculous. But that’s how many experts in the SMSF world said the ATO’s rules could be read.
A new ruling to clear the
Last week, the ATO came out with its interpretive ruling, SMSFR 2011/D1. If you want to read the full ruling, click here. Including all of the appendices, it’s more than 11,000 words long. A cure for insomnia, if you need one, will certainly come by about the 8000-word mark.
So, what’s important?
As expected, adding new bedrooms, extending the house, enlarging the kitchen, adding a garage, putting in a jacuzzi or adding a second story are still O … U … T, out if you are using borrowed money. You may be able to make these improvements by using other money from the fund, but borrowings cannot be used.
Restoring a kitchen, replacing the roof, painting the house or fixing cracked and dangerous footpaths will not be considered “improvements” to the property and borrowings could be used, it is now argued.
As always, it’s a matter of degrees.
If the roof gets ripped off in a storm, it’s acceptable to replace the roof. But if you think that you can try to sneak in the addition of a second storey (with a couple of bedrooms, bathroom and rumpus room during the replacement) using borrowings, think again.
You can’t demolish a house and replace it with three strata-titled units. You can’t have the land rezoned and then make the property commercial, or vice versa. Both of these would be considered making a “different asset”, which is not allowed.
Off-the-plan and building on land
Prior to the draft ruling, there were also plenty of questions about buying off-the-plan property. Were you buying a block of land, or a space in the air, on which an “improvement”, a building, was going to be constructed? The ATO’s draft ruling says it’s okay to purchase an off-the-plan property. You can pay the deposit in cash and then use borrowed money to purchase the balance of the property.
However, buying a block of land and then building a dwelling on it would make it a new asset, which is certainly not okay.
Subdividing a vacant block will make it two assets and is therefore not allowed. And if you “shift” a house that sits over two titles clearly onto one title, you will also have fallen foul of the rules.
Complex area – don’t do it without advice
The area of geared property in super is extremely complex. For a start, it can’t actually be held by the super fund – it needs to be held by a special purpose debt instalment trust (or bare trust). In writing today’s column, I have simplified, for the purpose of readability, many of the aspects of the ATO draft ruling.
For a few of my other columns on super property gearing, check out these articles (26/8/09, 21/4/2010 and 22/12/2010)
When dealing with geared property in super, you are dealing with an area that the ATO has made clear is a developing area over which it has major concerns (and extremely broad powers).
Even for those who think they know a lot about geared investment property, don’t attempt this without professional advice. The rules surrounding geared property in super have important differences that make it quite different to geared property in your own name.
The ATO is calling for submissions on SMSFR 201/D1. If you’d like to do so, you need to make your submission by 28 October. When completed, the draft ruling is proposed that the draft ruling will be effective for arrangements entered into since 7 July, 2010.
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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 advised to consult your financial adviser.
Bruce Brammall is director of Castellan Financial Consulting and the author of Debt Man Walking.