Since 2007 Australians have been able to borrow within a Self-Managed Superannuation Fund (SMSF) to purchase direct property. The Superannuation (Industry Supervision) Act 1993 (SIS Act) requires that this borrowing takes place using a Limited Recourse Borrowing Arrangement (LRBA) structure.
Buying property through an SMSF is a popular method of increasing retirement benefits through superannuation. There are many matters that need to be considered before establishing an SMSF, using it to invest in property and borrowing to do so. We would be happy to organise an SMSF Specialist to discuss your eligibility and assess your personal circumstances.
Borrowing within an SMSF differs slightly from regular home loan borrowing. The main difference being that an SMSF mortgage is more difficult to process, with fines of over $200,000 applying to trustees if their arrangements aren't properly structured. Speak to one of our TLC mortgage lenders and SMSF advisers who will provide you with a variety of options and guide you in choosing one that is suitable for your situation.
Steps to purchase a property through an SMSF
1. Establish an SMSF under a Corporate Trustee structure. We would be happy to organise a SMSF Specialist to assist you with this step. Note: In relation to a limited recourse borrowing arrangement (LRBA) for property investment, different lenders have varying requirements. Many of the larger banks and institutions typically require a corporate trustee. This is not a legal requirement to qualify for a LRBA. However, many banks have lending policies that favour having a corporate trustee.
2. Identify the type of property you wish to purchase and obtain a pre-approval for the loan amount required.
3. Decide who will act as a custodian for the property. The custodian holds the property title on your behalf until the loan is paid off, otherwise known as a 'bare trustee'. This will need to be noted in writing. The custodian is often required by your lender to be a company. The correct establishment of the bare trust is essential to avoid such things as double stamp duty when the loan is paid off. Specialist advice should be obtained and we can make sure you receive this.
4. You submit the home loan application along with all the required documentation.
5. The custodian issues payment of the deposit and contracts for the purchase of the property are exchanged.
6. If the loan is approved by the lender, the custodian puts the property up as security with the lender so the transaction can be finalised.
7. You cover the costs of stamp duty and legal expenses.
8. Upon settlement of the loan, you begin making repayments and cover other day-to-day expenses on the property as well as collecting the rent. If rent doesn't cover the repayments the difference will need to be made up through returns from other assets held in the SMSF or superannuation contributions.
9. Once the loan has been paid off, the title can be transferred to the SMSF from the custodian or the property can be sold off.
Application times for SMSF home loans
Using an SMSF to take out an investment loan is quite a bit more complex than submitting an application for a standard home loan. Generally, you'll find that it might take you about a week to gather the paperwork you need for the application and your lender at least another week to evaluate and accept the pre-approval application.
If you do not have an SMSF already established the process could be delayed further (up to 4 to 5 weeks). We would be happy to organise a SMSF Specialist to discuss your eligibility and assess your personal circumstances.
Every lender’s requirements will vary slightly in terms of their contractual conditions and how they’will assess your ability to service the loan, but the following administrative and legal requirements will be necessary for all LRBAs.
Your SMSF trust deed needs to permit borrowing and specify what assets you can purchase using borrowed funds. If it doesn’t, it will need to be amended before you can apply for a limited recourse loan. Some lenders also insist your fund has a corporate trustee. Others will lend to funds with individual trustees but for a lower loan-to-value ratio (LVR) or a lower percentage of the property’s purchase price. All lenders will expect to have their lawyers vet your trust deed.
Most lenders will want evidence that you are operating a complying fund before they will consider an LRBA application. They may ask for written evidence of your SMSF investment strategy or require scrutiny of your portfolio and several years’ of returns/accounts.
Most lenders require some form of written statement from a financial adviser as evidence that you have sought independent financial advice to ensure an LRBA is appropriate for your superannuation fund and retirement objectives.
We would be happy to organise an SMSF Specialist to evaluate the cash flow position and assess the suitability of a LRBA for your SMSF and provide the supporting documentation to you as the director/trustee of your fund and the lender for the loan.
Are my other super assets at risk if I default on my loan?
By law, you're generally only permitted to purchase an asset with your SMSF using a 'limited recourse borrowing arrangement' (LRBA). This means if you default on your loan, your lender cannot seize any of your other SMSF assets - only the asset that is the object of the loan. Any other assets your SMSF owns are protected. However, lenders may require personal guarantees outside of the SMSF.
How much can I borrow?
Lenders generally impose a maximum Loan to Value Ratio (LVR) for borrowers, as they are not legally allowed to have recourse over any of the super fund’s other assets. The amount you can borrow will depend on type of asset being purchased, your level of super contributions, rental income and other variables and differs from lender to lender. If you are looking at a standard SMSF investment loan, you'll usually be able to borrow as much as 80% of the purchase price. This depends on the lender, with some allowing a lower maximum of around 70% for SMSFs where the trustee is an individual.
If you're looking to purchase commercial property, most lenders will lend up to 70% of value of the property in most cases.
Lenders offering SMSF mortgages tend to have different policies which apply especially to how they analyse and evaluate your ability to pay back the loan. For this reason we recommend that you speak with a TLC specialist to determine your maximum LVR as they may be able to save you a lot of time, money and heartache.
There are some legal restrictions when it comes to using SMSFs to borrow money. There are certain rules a trust must abide by to be able to take out loans. Below you will find a basic, but not exhausted, guide to these rules:
The asset to be purchased is one that the SMSF could legally buy if it had the money to do so;
A 'security trust', also known as a 'custodian' or 'bare trustee', must hold the asset on trust for the SMSF;
From the very beginning, the SMSF obtains a beneficial stake in the property;
The SMSF is legally entitled to secure the legal title from the Security Custodian once the loan is paid off in full;
The lender is restricted to a single asset in terms of the action or 'recourse' it can take against the borrower if the latter is no longer able to make payments. In other words, the bank cannot lay claim to any other asset that belongs to the SMSF if your SMSF defaults on the loan;
Each loan can only be made out for one asset at a time, which means that separate loan arrangements need to be made in the case of strata titles or subdivisions since each title is viewed as a separate property.
There are some restrictions when it comes to any property bought by an SMSF when using a LRBA, namely that you can't construct a new home*, nor can you live in the home at any stage.
Note that if the purchase is for your business you may utilise the building for business purposes as long as rent is on commercial terms. While you can't sell a residential property to your SMSF if you or someone close to you owns it, you can do it with a commercial property.
*A ‘house and land’ package may be available.
You are not allowed to re-draw against the equity of an existing asset as this would breach the superannuation rules. For example you cannot use a property in your super fund as security to borrow further funds to acquire another property. The SMSF needs to have a separate deposit such as cash to secure another asset.
You can apply borrowed money towards expenses incurred in connection with the borrowing. However you cannot borrow money to construct a building on vacant land or use it to make improvements such as renovations (this would create a new asset).
Renovations and repairs are also a complex area in regards to SMSF properties:
You can renovate and repair your property, although this comes with conditions regarding how you finance these activities.
Regular maintenance on a property such as fixing leaking taps and other general running costs come with no legal problems.
Carrying out significant improvements on your property are usually not able to be financed with an SMSF loan, as it must be used for the initial investment it was intended for and not to purchase new investments such as a home extension.
Using funds from your own pocket rather than your SMSF to finance a renovation is another tricky area. Funding renovations with money from outside your SMSF could result in you personally owning some of the property while the SMSF owns another portion.
Alternatively, contributing more money into your fund to finance the renovations could also bring with it challenges as there are strict limits on how much you can contribute to your super each year. We would be happy to connect you with an SMSF Specialist that can discuss the options available to you.
You can seek a private ruling from the ATO to decide whether the work you're carrying out will be considered a significant improvement or part of normal maintenance. This gives you the backing necessary to help you follow the correct process.
A specialist SMSF adviser can help with these matters.
There are a number of guidelines on the ATO Website that discuss what a renovation is versus maintenance or repairs.
The Benefits of Purchasing an Investment Property in an SMSF
There are several major benefits associated with buying property through an SMSF with the most significant advantage being the favourable tax treatment of assets held in superannuation. They include the following:
Rental income from property in a SMSF will be taxed at 15% in accumulation phase, compared with rates up to 48% (including Medicare Levy) that a regular investor could be paying.
If the SMSF is in pension phase the rental income from the property will be tax free.
The cost incurred in purchasing and managing the property (interest, depreciation, rates, insurance etc.) could produce a negative income that you can offset against other income to reduce the tax within the SMSF even further.
Gearing (where you use borrowed funds to gain control over an appreciating asset) is one of the most effective long term wealth building strategies available to investors. An SMSF allows borrowing to buy property and fund the acquisition from Employer Superannuation Guarantee Contributions allows an investor to increase their wealth without affecting their personal cash flow.
On the sale of the property the Capital Gains Tax (CGT) is reduced to only 10% if the fund is in accumulation phase or nil if the fund is in pension phase (if current legislation is still in force).
Assets held in a SMSF will, under normal circumstances, be protected against general debt recovery (this does not apply in the case of the loan with which the asset was purchased) and bankruptcy proceedings.
The fact that an investor can transfer commercial property that they already own into an SMSF allows the investor to unlock cash to invest in their business or in other assets. The funds may also be used to re-contribute to the SMSF (subject to individual limits) to further improve the investors retirement position.
At Tamworth Loan Consultants we understand that the only thing more exciting than buying your home is paying it off. Our goal is to enable you to do both, as quickly and easily as possible. We are very different from the other Brokers and Lenders in the marketplace as we don't forget you after you have obtained your loan. We become your loan management partners and will assist you to put a debt repayment plan in place. Using our extensive technical knowledge we will recommend a loan or loans that will help facilitate debt management. We are an innovative Mortgage Broking firm with a passion for helping our clients to meet their lending and financial needs and objectives. We believe that cash flow management should form the basis of all financial journey’s as it will dictate your standard of living, capacity to borrow, ability to meet the cost of necessary expenditure and to save. To this end we offer a unique optional cash flow management service to our client’s where we do most of the work for you so that you have more time for other things. It is so important to have a team working for you that you can trust.