Understanding Property & Self-Managed Superannuation

Posted on Aug 30, 2012 | 0 comments

Properly managed a self-managed super fund (SMSF) is a particularly effective way of providing for your retirement. And for protecting certain assets.

It is however a highly regulated area and those contemplating managing their own superannuation should always seek professional advice before committing to it. For example it is essential that trustees of a self-managed fund realise that the sole purpose test is rigorously enforced.

The sole purpose test means simply that the fund is established to provide retirement income to the beneficiaries, and not for any other purpose.  There are of course many ways to invest to build retirement income assets.

Many SMS Funds are being established today to invest in residential property. This is not surprising given the tax advantages of superannuation and our collective love of residential investment properties as a way of building retirement wealth. Bear in mind though that an SMSF must have an investment strategy which should include appropriate diversification amongst asset classes.

It is important when establishing a property investment inside super that the proper process be employed. Here is a graphic representation of what is required:

SMSF

Once the correct structure is in place, but definitely not before this, lenders may be approached for finance.  The SMSF can enter into direct talks with the lender and will also borrow directly from the lender on a ‘limited recourse’ basis (this means that the lender is limited in any ‘claim’ against the fund to the property purchased, not to any other assets of the fund).  Finance documents will clearly spell out who the legal and beneficial owners of the property are.

Here are some common errors to avoid:

A prospective purchaser ‘falls in love’ with a property and decides they must have it as a part of their investment portfolio.  Letting emotion rule their decision making they make an offer and pay a deposit from personal funds to secure the property. They then decide to include the investment in their superannuation and think a self-managed super fund should be set up to own the new asset. So off they go to see their financial adviser.

This is too late and rectifying the situation can be very complex and expensive.

The better way to go about acquiring property in an SMSF is to properly plan the whole process. First plan the Fund’s investment strategy, then search out an appropriate property (it’s a retirement asset so don’t let emotion rule; you won’t be living in it so how lovely it is for you is not the issue). Next, but before signing any contracts, obtain pre-approval for undertaking the purchase through the Fund. All this should be done in consultation with a trained professional adviser.

Further traps for the unwary:

  • SMSF’s cannot redraw funds against the equity of the property so ensure this won’t be necessary by planning properly;
  • The security trust (diagram above) cannot enter directly into a loan arrangement with the lender, this is done by the Fund (through the trustees);
  • The transaction must be arm’s length, meaning for example that it is not with a related party (there are exceptions to this for business premises);
  • The lender cannot act as the holding trustee – this could result in a clear conflict of interest and is an arrangement that the ATO will likely take a dim view of;
  • The SMSF cannot be named as the buyer on the sale contract; this violates the arm’s length requirement for the security trust to act as purchaser and ‘holder’ of the property;
  • The purchase of the asset, the property in this case, must be in line with the investment strategy (as noted above ensure the investment strategy is formulated immediately upon establishment of the fund);
  • The security trust is established solely to act as a holding entity for the title deeds of assets, it cannot have other responsibilities i.e. it must not be an ‘active entity’ for tax purposes.

JWA Business and Wealth can help by keeping you on the straight and narrow and ensuring the establishment of your SMSF is both safe and as inexpensive as possible. Contact Joe Walsh (joe @ jwa.com.au) to obtain further information.

 

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