Since 2007 self managed superannuation funds (SMSFs) have been able to borrow to invest provided certain conditions are met (for details on the conditions see our previous blog post ‘Self managed super funds - borrowing to acquire assets’). In the wake of the global financial crisis there has been substantial growth in the number of super funds investing in this way.
Under the Government’s Simpler Super rules, superannuation is now more flexible and tax effective than ever. It can be the perfect vehicle for long term investments such as investment properties. A number of the key benefits of borrowing within super to invest in property are:
1. Tax concessions
Gearing within superannuation provides several tax advantages:
Low income tax environment
Net rental income is taxed at a maximum rate of 15% in an accumulating super fund, and nil tax in a super pension fund compared to upto 46.5% in your personal name.
Tax effective retirement
If you are 60 years of age and over there is nil tax on superannuation withdrawals or pension earnings.
Capital Gains Tax (CGT) savings
The maximum rate of tax applied to capital gains is 15% if the property has been held for less than one year, 10% if held for longer, and potentially nil if the property is sold when your superannuation is paying a pension.
2. Borrowing Capacity
A benefit of borrowing in super is that potentially your capcacity to borrow is increased as the servicing on the loan can be funded not only from tenant rental payments and other earnings of your superannuation fund but also from the following forms of super contributions:
Employer contributions - 9% super guarantee and salary sacrifice
Personal contributions - self employed may claim a tax deduction
Government super co-contribution - up to $1,000p.a.
For some people, gearing via superannuation may be the only way they can afford to invest into direct property.
3. Super is now simpler and more flexible
There are no longer any restrictions on how much you can withdraw in retirement and no requirement to withdraw any funds until age 75.
4. Gearing helps overcome the super contribution cap limits
Given the tax concessions and flexibility super now offers, the Government has capped how much you can contribute to super:
Personal contributions are limited to $150,000 p.a. or, if under 65 year of age, $450,000 over three years
Tax deductible contributions are limited to $25,000 p.a. ($50,000 p.a. for those over 50 years of age)
As borrowed funds do not count towards the Government contribution caps, they can enhance the size of your superannuation fund outside the caps allowing investments that would otherwise not have been possible. For example, a super fund with a $150,000 account balance could borrow $350,000 and have $500,000 invested for growth in the tax effective system of super.
Can my SMSF borrow to invest?
Essentially, you will need to have a complying self managed superannuation fund with approximately $500,000 total account balance to make it cost effective. If you don’t personally have $500,000 in super you can establish a SMSF with up to three other Australian residents and pool all of your super benefits together.
When establishing or reviewing your SMSF you must ensure that borrowing to invest into direct property is in line with your SMSF investment strategy and that your SMSF trust deed permits it.
However, property development (i.e. capital improvements) is prohibited under this structure and SMSFs wanting to develop property should consider alternative structures.
Risks to consider
Although there are great tax benefits and an opportunity to leverage into direct property, the following risks need to be considered:
While borrowing to invest can magnify your returns, it can also magnify your losses if the investment makes a negative return.
An integral part of an investment strategy in superannuation is diversification to minimise risk. Having only one type of investment in super generally wouldn’t comply with this rule.
If the property is negatively geared, you need to ensure that the super fund has adequate cash flow to meet interest payments.
The law can always change to prohibit borrowing in super, but generally when super law changes, existing investors are provided with exemptions.
Don’t forget that you can’t access your superannuation until you meet a condition of release, which for most people is being over 55 (increasing to 60) and retired.
Apart from commercial property, you can’t buy existing property from yourself or your relatives, and you can’t live in the property or use it for your own enjoyment, such as purchasing a holiday house.
Prior to entering anI borrowin arrangement in super it’s imperative that you receive expert advice to ensure that the arrangement you’re entering into complies with the super rules and doesn’t lead to any double taxing.
For example, a poorly-worded security trust deed could give rise to stamp duty being recharged and capital gains tax being triggered in the transfer of the property to the SMSF. An incorrectly structured instalment arrangement could also give rise to a breach of the super rules, where potentially half the fund’s value can be lost in penalties.
Before, investing into property via your SMSF it is imperative that you receive advice to ensure your investment complies with all the superannuation rules and all risks are considered. Grant Thornton can help. To find out more about whether investing into property via your SMSF could work for you, contact your usual Grant Thornton advisor or your local office.
This article is general in nature and its brevity could lead to misrepresentation. The information contained in this blog is not intended to be advice and could be subject to change. No responsibility can be accepted for those who act on its contents without obtaining specific advice from an advisor.