Investing in property through a Self-Managed Superannuation Fund (SMSF) has become a popular
strategy among Australians seeking to build wealth for retirement.
However, while the prospect of owning property within your super fund might seem like a golden opportunity, it comes with significant risks, complexities, and compliance challenges that investors often overlook. This article will delve into the key considerations, potential pitfalls, and traps that investors should be aware of when buying property within their SMSF, especially when borrowing is involved.
1. Borrowing to Purchase Property in an SMSF: The Basics and Risks
SMSFs can borrow money to acquire property under a Limited Recourse Borrowing Arrangement
(LRBA). In this structure, the lender’s recourse is limited to the property purchased, meaning the
lender cannot access other assets in your SMSF if the loan defaults.
However, the risks and complexities include:
- Higher Costs: Borrowing through an SMSF often incurs higher interest rates, fees, and strict loan terms compared to standard property loans.
- Cash Flow Challenges: Rental income generated from the property must be sufficient to cover loan repayments, property management fees, and other expenses, which could impact the fund’s overall cash flow and liquidity.
- Limited Lenders: Not all banks and lenders offer SMSF loans, restricting your options and often resulting in less favourable terms.
2. Understanding the Single Acquirable Asset Rule
The Superannuation Industry (Supervision) Act (SIS Act) specifies that an SMSF can only purchase a “single acquirable asset” under an LRBA. A single acquirable asset refers to a single property title or
an asset that is capable of being acquired separately.
Key Points to Remember:
- Definition: A single acquirable asset can be a single residential or commercial property but not multiple properties or a subdividable property unless acquired as a whole.
- Property Improvements: The property must remain substantially the same after acquisition. Any changes or improvements that alter its fundamental character, such as a significant renovation or subdivision, may breach the single acquirable asset rule.
- Borrowing Restrictions: Under the SIS Act, you cannot use borrowed funds to improve the property. Only repairs and maintenance to restore the property to its original state are permitted.
3. Restrictions on Improvements vs. Repairs and Maintenance
When investing in property through your SMSF, it is crucial to differentiate between improvements
and repairs or maintenance. The SIS Act imposes strict rules on what you can and cannot do with a
property purchased through an SMSF with borrowed funds:
- Repairs and Maintenance: These are allowable expenses, including fixing a leaky roof,
painting, or replacing broken fixtures. These actions restore the property to its original state without
enhancing or improving it. - Improvements: This includes any action that enhances the property’s value or changes its nature,
such as adding a new room, extensive renovations, or upgrading from a standard fit-out to a luxury
finish. Such improvements are prohibited when using borrowed funds and can only be made using
cash held in the SMSF.
Potential Compliance Risks:
- Breaching the SIS Act: Undertaking improvements with borrowed funds or significantly altering the
property’s character can result in a breach of the SIS Act, attracting severe penalties and putting
your SMSF’s compliance status at risk. - Implications for Property Value: While minor repairs maintain the property’s condition, unapproved
improvements may not only breach the law but could also lead to financial consequences if they
alter the asset classification.
4. Other Traps and Potential SIS Act Breaches
Beyond borrowing and improvement restrictions, several other traps could lead to breaches of the
SIS Act, endangering your superannuation savings:
- Related Party Transactions: Purchasing property from a related party or leasing it to a related party
of the fund can lead to compliance issues unless specific conditions are met, such as business real
property rules. - Liquidity Concerns: Property is an illiquid asset, and if your SMSF needs to pay benefits or expenses, having too much invested in property could create cash flow issues.
- Valuation and Market Risk: SMSF trustees must regularly value the property according to ATO
guidelines. Market fluctuations can affect your SMSF’s financial position, impacting retirement
outcomes.
5. Compliance and Professional Advice: A Must-Have
Given the complexities and risks associated with investing in property through an SMSF, professional
advice from financial advisors, tax agents, and SMSF specialists is essential. They can guide you on
compliance with the SIS Act, help navigate borrowing rules and ensure your investment strategy
aligns with your overall retirement goals.
Tips for Compliance:
- Consult Regularly: Consult SMSF professionals to ensure your fund complies with changing laws and regulations.
- Document Everything: Keep detailed records of all transactions, improvements, repairs, and
communications related to the property to safeguard your SMSF from compliance scrutiny. - Understand the Rules: Familiarise yourself with the SIS Act, particularly the rules regarding
borrowing, single-acquirable assets, and property improvements.
Conclusion
Investing in property through an SMSF can be a powerful strategy, but it is fraught with legal,
financial, and compliance challenges that must be navigated carefully. Understanding the SIS Act’s
requirements, especially around borrowing, asset definitions, and permissible property
modifications, is crucial. Before making any decisions, seek expert advice to ensure your property
investment aligns with your retirement objectives and stays within the bounds of superannuation
laws.
Remember, the allure of property investment should never outweigh the importance of
safeguarding your retirement savings. Proceed with caution, and always prioritise compliance and
professional guidance.
Should you require further information about purchasing property through your self-managed
superannuation, please feel free to contact Peter Quinn by submitting an enquiry or calling us on
+61 2 9580 9166 to book an obligation-free appointment.
The information in this document does not take into account your personal objectives, financial situation, or needs, so you should consider its appropriateness and consider these factors before acting on it. It is important that your personal circumstances are taken into account before making any financial decision, and it is recommended that you seek assistance from your financial adviser.