Aussies love property and they also love self managed super funds (SMSFs), so what better than borrowing to buy property in a DIY fund?
Before 2007, this was pretty well impossible – except for the mega-wealthy who could buy a property outright in their SMSF. In the old days borrowing in a SMSF was not permitted.
Well, those days are over and since a law change in 2007 it is now legal and feasible for a SMSF to borrow and invest in residential, commercial, retail and even holiday units, provided that the property is acceptable for the lending institution. The restriction is that you can’t live in it, and neither can any member of the fund or your relatives. So the property must be an investment, with the exception of business premises. It’s possible to buy a business property and use it within your business.
Why not just buy property outside your SMSF?
Well, that’s a good question and many people do prefer to leave property investments outside their SMSF, retaining them under their own name. These people prefer the flexibility of buying and selling property regularly; they may want to borrow against the property to fund other investments, or stgelop or improve the properties they purchase. All of these reasons make buying property in the rigid structure of a SMSF a big turnoff.
The primary reason you’d buy property in a SMSF is for tax savings; particularly for those who intend to hold onto the property until they reach pension age.
Let’s say you buy an investment property outside of super. When you come to sell it, you must pay capital gains tax on any profits made, and any rental income received is taxed at your marginal tax rate.
Instead, if you buy the property in your SMSF, any rental income is taxed at just 15 per cent, and once the SMSF moves into the pension phase, rental income is tax free. At this point, if the property is sold, no capital gains tax is payable. Indeed, any profit made on the property is tax free. The latter is probably the most significant benefit of holding property within a DIY fund, particularly within a rising property market. Other tax savings include tax deductibility of property expenses, such as interest on the investment loan, depreciation and so on.
So is it possible to buy a $2 million Sydney penthouse in your DIY fund?
Well, it all depends on how much money you’ve got stashed in your DIY fund. Financial institutions tend to let DIY investors borrow between 60-70 per cent of the property price tag, so for a $2 million Sydney penthouse, you’d have to allocate around $600,000 to the investment. A $500,000 property, on the other hand, requires a $150,00 deposit before costs (at a 70 per cent loan to value ratio).
Where do you get such loan? Most major banks offer packaged loans for DIY investors wanting to borrow money to buy property within their fund. It’s worth noting that the loan is different in structure and type to normal mortgages to buy the family home. Not only are the loans shorter in duration and the interest rate charged is a touch above the standard variable home loan rates, they are typically structured like instalment warrants, and yes, many of you would be acquainted with instalment warrants in the equities market, the best example being Telstra, T1, T2 and T3.
Essentially the way it works is your DIY fund makes an initial payment and pays the interest on the investment loan; after a period of time, the fund has the option of repaying the full amount and receiving full ownership of the asset.
An attractive feature of the loan is that it is non-recourse. It means that if you fail to make a repayment on the loan, the lender can’t go after your other assets in the DIY fund, or you personally. The lender only has access to the asset associated with the loan – in other words, the property. Take this as a good thing.
For some gruelling reading, the ATO ruling on this can be found here.
Next week we will explain how borrowing in your DIY fund can boost your super wealth and overcome contributions cap limitations. We will also investigate the downside of what happens to your super assets if the property market dumps.
This is for general information purposes only and does not constitute investment advice. Please see a financial adviser before making any investment decisions.