6 Mistakes People Make When Buying Real Estate in Their Super Fund
Mistakes to Avoid
Ken Raiss, Managing Director at Chan and Naylor, a national accounting, finance and wealth advisory group, has seen many people make these mistakes when purchasing real estate in their Self Managed Super Fund (SMSF). He wanted to share them to help others steer away from making the same mistakes.
Your Self-Managed Superannuation Fund can borrow money to:
- Purchase a property (including all acquisition costs),
- Pay for repairs and maintenance and
- Capitalise interest.
You cannot use borrowed funds to improve the property. Improvements include additions, granny flat, extensions etc. For these activities cash resources of the fund must be used. You can however use borrowed funds for cosmetic renovations. It is critical to keep good records in your SMSF to identify whether borrowed funds or internal cash is used. When debt is used, the property must be held in a Holding Trust with a Corporate Trustee and not directly in the SMSF.
Apart from the legislative requirement to not hold the property directly in the SMSF there are real and practical reasons why you would not want to hold it in the SMSF.
2. Associated Party Loan
Many people use external funds to assist them in purchasing property in their SMSF by contributing the cash as a non-concessional contribution. The problem is that once contributed you cannot get the funds back until retirement or worse still you cannot put in sufficient funds within the allowable limits. You can however lend the funds to your superannuation which allows its release if refinanced and there is no limit on the amount of the loan.
The mistake that many people make is to lend the funds with a simple loan agreement. The loan agreement must meet the limited recourse borrowing requirements of the legislation as well as clearly identifying all terms and conditions. Note: Market Interest Rates must apply.
Renovations which merely return the component back to a new condition are classified as repairs for the purposes of the superannuation borrowing legislation. Therefore a cosmetic renovation which replaces the existing kitchen or bathroom is allowable even with borrowed funds.
The mistake often made is to improve the kitchen by say extending the bench area or knocking down a non-load bearing wall. The latter two are deemed to be improvements and must use internal SMSF cash. It is a simple matter to ask your builder to split the invoice to show the improvement as a separate piece of work which can then be funded with cash and not borrowed funds. If a property is demolished and say a duplex is built or land is initially purchased and then a separate contract to build is entered into then these are changes to the original asset and cannot be done within the SMSF while there is still an outstanding debt on the property.
4. Life Insurance
Life insurance premiums are tax deductible in super. A common mistake is to assume this is still valid if the SMSF fund takes out a policy to repay debt on the death of a member. It is not. For the premiums to remain tax deductible they must not relate to the specific use to pay down the debt. Insurance to effectively achieve the same outcome and be tax deductible is possible with the correctly worded SMSF and policy identification which may also improve the liquidity of the fund if a death benefit arises in a fund holding property with debt.
5. Stamp Duty
When the debt is paid down the property must be transferred from the holding trust into the SMSF. Many states will charge stamp duty at the full property transfer rate. With the initial use of additional documentation at the time of purchase the second stamp duty trap can be avoided.
6. Purchasing From a Member
While the SMSF can purchase a residential property from a non-related third party, it cannot purchase a residential property off a member or related person of the member. An SMSF can however purchase listed shares or business real property (commercial and industrial) off a member. There will be CGT and stamp duty consequences to the sale but in relation to stamp duty most states allow for a minimal stamp duty if the property is in the individuals name and they are also the SMSF member directly benefiting from the property in the SMSF.
This article was written by:
Managing Director – Chan & Naylor
Chan & Naylor, National Property Business Tax Accounting & Wealth Advisory Group - Australia’s Fastest Growing and Top 100 Accounting Firm (BRW 2007, 2008, 2013)
For more information or to talk to a Chan and Naylor Property Tax and Wealth specialist click here
About Chan & Naylor
Chan & Naylor is a national accounting, finance and wealth advisory group that specialises in financial services for property investors. With 16 offices located in NSW, QLD, VIC, SA & WA and a team of caring professionals in property tax accounting, finance brokering and financial planning, Chan & Naylor is well positioned to support you in growing and protecting your wealth from generation to generation. For more information, to visit our latest news blog and subscribe to our monthly newsletter, please visit our website www.chan-naylor.com.au
This information has been prepared as a general guideline, and is not intended to be an exhaustive or a complete analysis of the topics in question or issues raised in this article. There are many particular legal, taxation and accounting matters which have not been dealt with in this article and readers are urged to discuss any aspect of the operation of any of these matters discussed herein with their professional advisers. Before taking any action or implementing any strategy you should seek professional advice from your lawyer, accountant and or financial planner who will take into account your specific circumstances and objectives.