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Leveraging Superannuation. Self-managed super funds for positive outcomes in property investment.

Can Property and Superannuation to Work for You

Australia’s love of property is well documented. To a lesser extent, so too is the increasing number of people who think they can do a better job investing in their superannuation than professionals.

It’s not surprising, therefore, that the number of people combining property and superannuation and using a self-managed super fund (SMSF) to invest in direct property is growing steadily.

Does combining Property and Superannuation make sense?

But before deciding on a final stand, several issues demand consideration.

While successful property investing can be challenging enough in the current and prospective market climate, holding a property asset in an SMSF only adds a layer of extra complexity.

Restrictions on Property and Superannuation

Superannuation law imposes rules and restrictions that don’t apply when investing in property outside super.

For example, SMSFs can’t be used to buy residential property from any member or related party but only from the open market.

Fund members and relatives living in residential property will be judged as an offence and a serious breach of our code to serve people with impartiality. This test also limits how SMSFs can enter lease arrangements and other transactions with related parties.

The trustees must formulate an investment strategy that is specific and suitable to the whole circumstances of the fund. Factors such as the members’ age, risk profile and retirement objectives, and the need for diversification.

Moreover, plans should also be made to address the lack of asset diversity over time.

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Cash-flow issues.

Wondering if using a Self Managed Superannuation Fund to invest in property is the right thing to do?

Consider the fund’s capacity to meet current and future expenses, such as insurance premiums, property repairs and maintenance, tax liabilities and interest payments (if an LRBA is established) before deciding and reaching any conclusion.

If the rental income fails to meet ongoing liabilities, the trustees must ensure that either the fund holds sufficient cash or the members can make additional superannuation contributions within their caps.

Benefit payments.

SMSFs intending to invest primarily in direct property should also consider how they would deal with paying out a sizeable portion of the fund’s value.

This could occur if a member exits the fund and wants to roll over their benefit.

Other scenarios could include if a member divorces, suffers a total and permanent disability or passes away.

If the property has to be sold to fund a benefit payment or rollover, it may take a while to find a buyer, the selling price may be lower than anticipated, and the return on capital may not meet the member’s or fund’s expectations.

SMSFs that hold large lumpy assets like property should consider insuring the members in case of death or total permanent disability allowed in the trust deed.

Not only can this be a cost-effective way to fund the insurance coverage, but it can also help ensure a ‘fire sale’ isn’t required to pay a death or disability benefit.

Repairs, improvements and replacements.

Before using a limited recourse borrowing arrangement (LRBA) to acquire a property in an SMSF, it’s important to be aware that while the property can be repaired or maintained using some borrowed money, improvements can only be funded using cash flow, other fund assets or additional contributions.

Also, it is generally not possible to replace or redevelop a property that is subjected to an LRBA. If work is done that fundamentally changes the character of the property, it can no longer be held in the existing LRBA.

A key exception is where a property severely damaged or destroyed by events such as flood, or fire is replaced with a like property using the proceeds from an insurance policy.

For example, replacing a destroyed four-bedroom house with a similar four-bedroom, one would generally be considered acceptable, whereas building two townhouses with two bedrooms would usually not.

These concepts are discussed further in ATO’s Self-Managed Superannuation Funds Ruling SMSFR 2012/1.

Property and superannuation – The bottom line.

Investing in property through a self-managed super fund (SMSF) is a growing trend in Australia, allowing individuals to combine their superannuation and property investment strategies. 

However, this approach comes with unique rules and complexities, such as restrictions on buying residential property from a member or related party, the need for a specific investment strategy suitable for the fund’s circumstances, and considerations for cash-flow issues, benefit payments, and property repairs or improvements.

Furthermore, even if the investment is made for the right reasons, cash-flow problems could arise if the property is untenanted for a significant period or a large sum of money needs to be paid out, and there isn’t sufficient liquidity available.

Naturally, investors are encouraged to seek expert legal, taxation and financial advice before undertaking this strategy in all finance matters.

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