According to the ATO, over 30,000 Self Managed Super Funds (SMSF) are set up yearly showing a growing trend of Australians wanting to have more of a choice over how they invest for retirement. A major driver of this is Australians who want to invest in specific properties of their choosing.
So how does this work? And what are the benefits of holding a property in a SMSF?
One of the common rules in relation to SMSF is that you generally can’t invest in any assets for personal use, or you will breach what is known as the sole purpose test.
Any investment that your SMSF makes, must be for the sole purpose of paying benefits to members in retirement and NOT for personal use prior to retirement.
Although your SMSF is free to purchase any property type — residential, commercial or vacant land — as a general rule, it cannot purchase these properties from anyone who is a related party, except in certain limited circumstances. There are also restrictions on renting property owned by your SMSF to related parties, with some exceptions.
Related parties include:
- Members of the Fund
- Relatives of each member
- Business partners of each member
- Spouse or child of those business partners.
- A company the member or their associate's control or influence
- A trust the member or their associate's control
Property that is defined as business real property is an exception to these rules. Business real property generally means land and buildings used wholly and exclusively in a business.
Examples of business real property include:
- A shed or office premises used by your own business
- A farm where a business of primary production is carried on
Your SMSF could therefore own the premises where you operate your business from and lease it to you for market rent. The rental income would be taxed at the super fund tax rate of 15% and you would be able to claim a tax deduction for the rent at your normal tax rate.
Your SMSF may purchase an existing business premise (either from you or from an unrelated third party), or you may alternatively decide to purchase a vacant block of land in your super fund and build a shed for your business.
Note however that if you are purchasing a block of land and building, there are restrictions on who you can purchase from and how the building process is conducted. If borrowing is required then professional advice should be sought to determine if your SMSF can be used or if a different structure is required.
Even if the SMSF is not borrowing, due to the complex administration, prior to setting up an SMSF or purchasing a property, you should seek professional advice from an accountant and financial advisor to go through the following:
Capital Gains Tax (CGT)
Registering for GST may be required for your super fund, depending on the nature of the property purchased and how you will be using the property. If the annual commercial rental will be $75,000 or more, then your fund will be required to be registered for GST. If the rent is less, then the GST registration is optional. Professional advice needs to be sought prior to purchase to determine if GST registration is required.
Capital Gains Tax (CGT)
When the SMSF sells the property, a rate of 15% tax will apply to the capital gain unless the fund has owned the property for 12 months or more, in which case the rate will be discounted by 1/3 resulting in a tax rate of 10%. If you wait until you retire and commence a pension in your SMSF before selling the property, the tax rate could be as low as 0%.
Retirement may happen when:
- The member reaches preservation age (now 60 for most people) and retires OR
- Turns 65 years of age
A super fund is entitled to a land tax threshold; this means that a SMSF can hold up to $755,000 of land and pay no land tax. Land values in excess of the threshold will be taxed at 1.6%. The land tax is assessed on the land held on the 31st of December, pre-planning is pivotal in avoiding unnecessary land tax liabilities.
This is capped at 15%. With the current company tax rate at 26% and individual tax rates up to 47%, tax can be saved by having positively geared property in a SMSF which can then be reinvested, creating a compounding effect by making earnings on your tax savings. The opposite, however, applies for negative gearing, as any tax benefit is at a lower rate for a super fund and could be nil depending on the super fund status.
Managing cash flow is particularly important when using a self managed super fund to purchase property. There are restrictions on contributions and how much money can be put in to a super fund to cover cash shortfalls. It is important to manage super fund cash flow when purchasing property as there must be sufficient cash left in the fund to pay expenses such as administration fees, insurance fees and any tax liabilities.
Example 1: Building a shed with money in your SMSF
John a Plumber from Shoal Bay has a self managed super fund "Johns Retirement SMSF" with a cash balance of $450,000. He sees a block of land at Taylor’s beach for $200,000 + GST on which he could build a shed that would suit his plumbing business perfectly. He sees this land as a good investment for his super fund with a good rental return once developed. John knows that a shed would be perfect for his growing business and would rather purchase and rent from his superannuation fund than from another landlord.
John should firstly seek advice through the assistance of his accountant or advisor, who must be properly licensed, to make sure that the investment is appropriate for his circumstances.
The Johns Retirement SMSF then purchases the land for $220,000. The Johns Retirement SMSF registers for GST prior to the purchase and claims the $20,000 GST paid in the purchase price on the first Business Activity Statement (BAS).
The Johns Retirement SMSF then decides to employ the services of a builder. The builder is not a related party and the Johns Retirement SMSF pays the builder $220,000 including GST in stages to complete the build of the premises. The Johns Retirement SMSF claims credits of $20,000 throughout the process.
On completion, John’s Plumbing moves into the premises. He has the rent valued by an independent property agent and pays market rent of $44,000 pa to the Johns Retirement SMSF. The SMSF remits $4,000 to the tax office as GST collected, and John’s Plumbing, who is also registered for GST, claims the $4,000 GST paid. Therefore any GST payable by the Johns Retirement SMSF is claimable by John’s Plumbing.
Land tax is not a concern as the land only has a value of $200,000 well below the $755,000 threshold where land tax would be payable.
Cash flow is not an issue as the fund had ample funds to cover the build. There is no cash flow pressure as rent is paid by the business on time, and costs to maintain the property, as per the lease, are paid by the Plumbing business. In this case, rent monies would be sufficient to cover fund costs.
Income tax on a yearly basis — the SMSF has rent received of $40,000 after GST and must pay tax on this amount at 15% resulting in tax payable of $6,000. As John has a marginal tax rate of 39% (incl Medicare Levy), and John is claiming the rent paid as a deduction, John’s tax is reduced by $15,600. This results in an overall tax saving of $9,600, which is invested in the Johns Retirement SMSF creating a compounding effect.
Capital Gains Tax and GST when selling the property
Many years later, John is 62 and retiring and the Johns Retirement SMSF is looking to sell the property for $500,000 plus GST. Next Generation Plumbing, a young Plumber, expresses interest in purchasing the property and as John is retiring, he offers to have Mark from Next Generation Plumbing rent the premises on a 6 month lease to see if the premises suits Mark. After 3 months, Mark is satisfied with the premises and decides to purchase them from the Johns Retirement SMSF.
The sale value of the premises is $500,000, and if Mark purchases the property in another entity (e.g. his SMSF) as there is an existing lease in place, the shed can be sold as a GST free going concern. The total price that “Next Generation Plumbing” pays to Johns Retirement SMSF is $500,000 and no GST is remitted to the ATO.
As the property has been sold at a profit, capital gains tax will be payable by Johns Retirement SMSF. If John is not retired, the calculated tax is as follows:
|Less Land Purchase excluding GST||($200,000)|
|Less Building Costs excluding GST||($200,000)|
|Gain on Sale||$100,000|
|Less Capital Gain Discount 33.33%||($33,333)|
|Taxable Capital Gain||$66,666|
|Tax Payable at 15%||$9,900|
If John is retired and drawing a pension from his super fund, the tax on this gain would in most cases be reduced to nil. It is important to seek advice on retirement to ensure the nil tax rate can be utilised.
As demonstrated by the example above, there are potential tax savings by holding a business property in a SMSF.
Instead of building, John may have alternatively purchased an existing business premises in his SMSF.
Example 2: Buying an existing shed in your SMSF
Peter, an electrician, has a SMSF with a cash balance of $450,000. He currently rents an existing shed for $2,500 + GST per month where he operates his business from. Peter operates his business through a company — Pete’s Electrical Pty Ltd.
The landlord Jo, decides to sell the shed and Peter thinks that he might purchase the shed in his super fund as he sees the commercial property as a good investment and would rather pay rent to his SMSF than to another party. The asking price for the shed is $400,000 plus GST
Peter seeks the assistance of his accountant or advisor, who must be properly licensed, to make sure that the investment is appropriate for his circumstances.
Peter’s SMSF registers for GST prior to the purchase. As part of the purchase, the current lease to Pete’s Electrical Pty Ltd, is transferred from Jo's to Peter’s SMSF. As the lease is transferred as part of the sale, the sale will be a sale of a going concern and GST free.
Peter has the rent valued on a regular basis to ensure that the rent is at market value and the super fund continues to charge GST on the rent.
Pete’s Electrical Pty Ltd continues to get a tax deduction for the rent at the company tax rate of 26%. The SMSF pays tax on the rent at 15%. Based on an annual rental income of $50,000, the tax payable by the SMSF would be $7,500.
The rent received by Pete’s super fund after tax is growing Pete’s retirement savings by $42,500 per year.
As Pete’s super fund purchased the property from an unrelated third party, stamp duty will be payable on the purchase. If however, Pete had owned the business premises in his own name, he could sell the property into his super fund and if structured correctly, only nominal stamp duty would be payable.
Example 3: Using borrowing in your SMSF
Using the same example above, except that the balance in Pete’s self managed super fund is $250,000. Pete’s SMSF will need to borrow to be able to finance the purchase.
There are very strict rules relating to borrowing in SMSF and these must be followed correctly or the super fund will be in breach and risk penalties.
Prior to entering into a contract to purchase, Pete must consult his accountant or advisor to ensure that the borrowing is structured correctly and the correct documentation is completed. Another company, separate from the existing trustee of his super fund, will need to be established and it will hold the legal title to the property.
Pete’s super fund uses $150,000 of its existing funds and borrows $250,000 to fund the purchase. It also funds the stamp duty and legal costs of approximately $20,000.
XYZ bank agrees to lend to Pete’s super fund and the loan has a 15 year term with an interest rate of 4%. The monthly loan repayments are $1,850 per month. As the current rental is $2,500 per month, there will be sufficient cash flow to cover the monthly repayments. The super fund will also need to take into account other expenses such as rates and insurance when reviewing the cash flow of the fund.
The self managed super fund will get a tax deduction for the interest expense and for any other outgoings related to the property.
In this example, the rent income covers the loan repayments, however if the super fund borrowed a higher amount, the interest rate rose, or large repairs were needed, additional funds via contributions may be required.
Purchasing a business premises in your SMSF, can be a worthwhile and attractive investment if structured correctly. All options will require advice from your accountant or advisor before implementing, and you should always consult your financial advisor to ensure that the options are best for your circumstances.
General Advice Warning: The information contained in this article is general in nature and does not consider your individual objectives, financial situation or needs. Before acting on anything in the preceding article, you should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice from a licensed financial advisor. Taxation, legal and other matters referred to in this article are of a general nature only and are based on interpretation of laws existing at the time and should not be relied upon in place of appropriate professional advice