One key difference between self-managed super funds (SMSFs) and retail or industry super funds is that SMSFs can invest directly in residential or commercial properties.
But just because you can do that with your SMSF, does it mean it’s a good idea? Read on to find out.
SMSF property investment statistics
According to the latest statistics from the Australian Taxation Office, Australian SMSFs have:
- over $80 billion invested in non-residential property.
- over $43 billion invested in residential property.
- over $56 billion in limited recourse borrowing arrangements (LRBAs).
Any SMSF borrowing to buy property must be done under an LRBA. An LRBA protects the rest of the assets in the SMSF from any lender claims if a borrower doesn’t make scheduled loan repayments.
SMSF investment strategy
One of the requirements of setting up an SMSF is developing a documented investment strategy. Any SMSF investments that you make must be consistent with this strategy, including any property investments.
The benefits of investing in property via your SMSF
There are several benefits of investing in property via your SMSF.
1) The potential for long-term capital growth.
History shows that Australian property prices have a long-term record of growth, especially if you hold onto it for seven years or more. This makes it an ideal long-term investment for many SMSFs.
Good properties in good locations tend to achieve the highest rates of growth.
2) The potential for ongoing rental income.
Property can generate ongoing rental income from tenants in addition to long-term capital growth.
3) Tax benefits.
Any rental income your SMSF property generates is taxed at the concessional superannuation rate of just 15%.
Investment properties outside of super, on the other hand, are taxed at your marginal rate. Your marginal tax rate depends on your income, but if you’re earning an average income, it’s more than double the tax rate on super.
If you’re earning a high income, you’ll pay up to three times more tax on investment property income.
4) Capital gains tax (CGT) discount.
Selling your property and making a capital gain outside of super will see the gain taxed at your marginal tax rate, but selling property inside super let’s you take advantage of tax discounts:
- When you make a capital gain inside super, the tax rate on the gain is 15% (the super tax rate).
- If you have held onto your SMSF property for at least 12 months before selling it, you will get a 33% CGT discount on any profit you make — effectively making the tax rate 10%.
- If you sell your property for a gain when you’re in retirement phase, there is no tax liability — the CGT would be zero.
5) You can buy more expensive properties by pooling members’ funds.
More expensive properties tend to generate more capital growth and more rental income.
6) You can lease your own commercial property.
Your SMSF can lease commercial property (such as office, retail, warehouse or factory space) back to your own business.
The limitations of SMSF property investments
While there are several benefits of buying property through your SMSF, it’s also important to be aware of the limitations.
1) None of the members of your SMSF (or any relatives) can live in the property.
2) None of the members of your SMSF (or any relatives) can rent the property (unless it is commercial property).
3) Property is expensive, and purchasing it in your SMSF will reduce the diversification of your investments. This can increase your exposure to risks such as property market downturns. And as mentioned earlier, buying property inside your SMSF must be consistent with your documented investment strategy.
4) Property is not a liquid investment. It may not be able to be sold quickly (or in favourable market conditions) if one of your SMSF members needs to be paid out quickly (for example, if one of your members dies).
5) If you borrow to buy property, the LRBA may restrict any modifications you can make to it.
6) It can be costly to set up an SMSF. The financial benefits (capital growth, rental income and tax savings) need to outweigh this cost.
As you can see, there are pros and cons to buying property inside your SMSF. It’s best to seek independent financial advice based on your specific SMSF circumstances, needs and goals before deciding.
If you’d like to learn more about purchasing property with super, please don’t hesitate to get in touch.