More and more investors are using their Self-Managed Superannuation Fund (SMSF) to invest in property, with a steady increase over the past decade.
However, SMSF property investment is much more involved than the traditional route taken by investors in the past, with a gamut of legislation that must be strictly adhered too as well as a number of key strategies that will maximise its wealth creation benefits.
Here are five blunders that should be avoided when purchasing property in super:
1. The wrong name
When purchasing a property in your SMSF with debt you should have set up a Holding Trust with a corporate trustee, which will be the legal owner of the property and will appear on title.
This is the name you use when signing the contract.
People are often confused when they believe the property is owned by the SMSF and use this name, but this is incorrect.
This is the most severe error as an SMSF can’t purchase a residential property off a member and a change from your name to the SMSF is expressly forbidden.
The other concern with changing the purchaser is that in many cases it triggers a second stamp duty.
So, always make sure you sign any sales contract, and any other additional legal documentation, using the Holding Trust corporate trustee name as the legal owner of a SMSF property.
2. Insufficient reno funds
While legislation allows for cosmetic renovations on the property while debt is outstanding, in reality banks are reluctant to lend for this.
Therefore, to safeguard yourself, you as the SMSF member (or other persons) can lend to the fund.
If the banks do end up lending you the funds, then you repay the member loan.
The loan must be structured as a Limited Recourse Borrowing Arrangement (as per the legislation) and must be at arm’s length terms, which the Australian Tax Office sets out the terms for interest, principal repayments and security, etc.
3. Life insurance
Many SMSFs feature a number of family members banded together to increase available funds. An issue that sometimes comes up is that if a member dies their balance must be paid out.
This can create issues with a property as it can’t be “half sold” so the whole property is sold if there aren’t enough other funds or assets – even if the remaining members don’t want this.
People also incorrectly believe that life insurance proceeds can be used to pay down debt and even to retain the property in the SMSF, but this is incorrect as both the life policy receipts and the proportion of the property must be paid out.
But, in many cases, a properly-worded SMSF deed and appropriate life policy can allow for the property to be retained in the SMSF.
4. Rollover of funds
It’s common for people to set up a new SMSF to buy a property and then to roll over funds from their retail/industry fund.
But caution is needed regarding insurances, which may be too expensive if sourced through the SMSF or not available at all.
If this is the case, then it is allowable to retain some moneys in the existing fund, then roll over only the appropriate amount and therefore retain insurances in the existing fund.
Some investors are also surprised if the rollover amount is lower than what they saw on their investment statement.
This is usually because the statement shows the current value and when you ask for a cash rollover the fund must sell assets and this may trigger capital gains tax.
5. Leverage and risk
Many investors also don’t understand the implications of leverage and risk when they use a SMSF to buy property.
If you purchase with debt then the property must be held outside of the SMSF in a Holding Trust, but when the debt is paid off the property must be transferred to the SMSF.
The transfer can increase risk in the SMSF in the case of litigation, which can expose all your SMSF assets.
Therefore, you should consider either keeping a small outstanding loan or put in place a small member loan.
It’s also important to consider that even with a cash purchase you should put the property in a trust which the SMSF “owns”.
Buying property in a SMSF can provide long-term wealth benefits, but you must be aware of all of the pros and cons, as well as the rules and regulations, before you decide whether it’s the right strategy for you.