(03) 9020 2905PORTFOLIO POINT: Residential property and your SMSF … today, we sort out a few misconceptions.
There must be a great sociological explanation for Australians love of dirt, bricks and mortar. But I’ve not yet heard it.
In unequal parts, it’s about security, because we understand property as an asset class, it’s less volatile than shares and tax. For others, it’s about the gearing – banks will lend significant amounts of money for property.
It’s always been a frustration that the same rules don’t apply inside our SMSFs!
The biggest problem with property and SMSFs has traditionally been one of cost. In order to buy a property, a SMSF needs to have a minimum of $300,000 or $400,000 to purchase a property. Then, on top of that, they need some other money for more liquid assets – cash, bonds and shares.
Well, with a few exceptions, the rules have been changed and now are the same for holding residential property inside super. There are a few exceptions and there are many misconceptions. Today, based on the regular questions being posed to Eureka Report, we’ll tackle five of the major misconceptions about residential investment property, geared or otherwise, inside your SMSF.
Misconception 1: I’d like to transfer my residential property into super
Simply, no you can’t. If you own a residential investment property in your personal names, that is where it must stay. It doesn’t matter whether the property is owned outright or has a mortgage. It doesn’t matter whether the property is your home, a partially leased holiday home, or a full-leased property. The answer is no.
It’s a rule straight from the Australian Tax Office. While you can transfer in shares and commercial property and many other types of assets, residential property is a blanket no.
The rule apparently stems from a distrust on the part of the ATO over whether trustees can be trusted to transfer in residential property at a market price. They don’t have the same fear over commercial property, which can be transferred in, or purchased, by a SMSF from a trustee owner. But it is understood that the ATO believes residential property transfers would leave open the potential for abuse of contribution limits and is therefore not allowed.
Hopefully, this will be reconsidered by the ATO over time. But for the time being, the rule is in place and is staying put.
Misconception 2: You can’t gear for property into super
“But gearing doesn’t apply to super!” I hear you cry. Well, it does. And it’s increasingly surprising that so few people aren’t aware of this. Australians CAN gear into property through their SMSF.
Changes made by the outgoing Howard Government mean that you can gear into property inside your DIY fund. In fact, as of September 2007, super funds can gear into any investment that it is legal for a super fund to invest in.
While the changes were made nearly two years ago, investment markets have been too distracting for many to concentrate on geared property in super. The crashing of equity markets, and the near disintegration of listed property trusts (now known as real estate investment trusts) means that the potential for geared property hasn’t received the focus that it may otherwise have had.
Residential real estate was a very difficult asset class to hold in superannuation because of its size. In today’s dollars, at a minimum, holding an investment property would mean a super fund had to have about $300,000 or so invested to buy even a smallish metropolitan inner-urban flat or outer-suburban home.
The “super gearing” changes mean that Australian SMSFs can borrow more than half of the purchase price, plus stamp duty and other costs.
In many cases, the SMSF might have just 30-40% of the property’s value, if a commercial lender is being used. So, to buy a $400,000 suburban house, you may need as little as $140,000 or so (30% of purchase price, plus stamp duty and legals) to fund the purchase, with the remainder coming from a lender.
The lending restrictions are imposed by the lenders because of the law, as the new laws state that the loan must be non-recourse. As a result, lenders are only likely to lend to a percentage that they’re confident they could recover in the event of a fire sale. This means that few lenders are willing to lend more than about 70% of the value of a property.
It is possible to have very high levels of gearing within super if the lender is willing to take the risk and the loan is non-recourse. Who would do this? For a start … you might. It is entirely feasible that, if you had the means available outside of super, that you might wish to lend the money to your super fund. But be very careful – make sure that you have all the legal requirements in place, including compliant loan agreements.
You may even wish to do a combination of both of the above. You might find that you wish to loan 35% to your super fund and that another lender is prepared to lend 70% (the extra 5% being for legals). Again, be careful. Make sure that you seek professional advice from an adviser before heading down this path.
Misconception 3: You can’t negatively gear in super
And if you can gear into super, you can most certainly negatively gear in super. There is nothing in the regulations that denies it.
It just doesn’t work as well, in many respects, as negative gearing in your own name.
Let’s take an example. You’ve bought a $400,000 property, borrowing 70% at 7% (so interest costs are $19,600). The rent for the property is $280 a week, or $14,000 a year (allowing two weeks for vacancy). Your other costs, including agent fees, insurance, rates, body corporate and $2000 for maintenance works, is $6620.
Total costs: $26,220. Income: $14,000. This property is negatively geared to the tune of $12,220 a year.
As a super fund’s tax rate is 15%, the super fund would be up for a return of $1833, which would reduce the net cost to a loss of $10,387, which you’ll need to fund from within your fund, or through extra contributions to your fund. (Obviously, if the property was held in your personal name on a higher tax rate, the tax benefits would be considerably greater.)
The great bonus, however, is that if you sell the property for a profit after you’ve turned your fund to pension phase, you won’t have to pay any capital gains tax on any profit.
Misconception 4: You can only buy what your lender will let you buy
Wrong!
While there are plenty of lenders tied in with property developers and real estate agents offering pre-packaged properties at seminars, they aren’t the only option. They are most likely the easiest option. They might be a low-fuss option. But they are not the only option.
You can buy any property you wish to buy (except, as discussed above, one that you already own). The restrictions may be what sort of property a lender is prepared to take as security.
Misconception 5: The fees for buying property in super are ridiculous.
Well, they are high. But they are no longer very high. And even very high was a step down from what was, initially, ridiculous. They are nowhere near what they were 18 months ago and they’re continuing to fall.
There are a lot of players who have entered this new market for property gearing inside SMSFs. And, as a result, quality is varied, as are the prices being charged.
With the usual consumer warning that you get what you pay for, highly reputable legal firms are charging around $3000-$4000 for a purpose-built “debt instalment trust”, plus accompanying documents. There are many other providers who will charge a lot less. As with everything, research the company you are considering using (and if in doubt, pay a little more to go with a company that has a reputation with some value).
Some providers, including the Commonwealth Bank, insist on their version of the “debt instalment trust” being used. They also insist on being, in essence, the property manager, to insure that bills, rates and insurance are paid. For this, of course, there is a fee charged (which amounts to approximately $1000 a year).
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None of the recommendations in this article should be taken as personal investment or financial advice. In any investment program, your personal situation and needs should be taken into account. Please see your adviser/s before implementing any major changes to your investment program
Bruce Brammall is director of Castellan Financial Consulting and author of Debt Man Walking.