Borrowing to invest within your SMSF
Self-managed superannuation funds (SMSFs) open up a whole new world of investment opportunities for your retirement savings, including direct property. But what if you simply don't have enough money in super to buy an asset outright?
Traditionally, you may have had to consider borrowing the balance yourself and then becoming joint owner of the investment with your super fund. Perhaps this would have been set up through a trust structure to give you flexibility later on.
However, changes to legislation now permit SMSFs to borrow money directly to fund the purchase of direct property. As with any SMSF investment, for this to be allowed, strict criteria must first be met.
Compliance is essential
In 2012 the ATO issued an alert ATO Statement to emphasise the need for compliance with the borrowing rules. Specifically:
Only commercial property or residential property used for investment purposes can be purchased and these transactions need to be made at “arm’s length” on a strictly commercial basis.
Any property must be purchased as a single asset.
Loans used for purchasing property need to be made on a non-recourse basis.
The property title must be held in the name of the trustee of a Bare Trust, not the trustee of the SMSF or any member of the SMSF.
To assist in enforcing compliance the ATO has been given a range of new powers including the imposition of administrative penalties and rectification and education orders against SMSF trustees.
How it can work
We will use a case study to demonstrate how this works and, in this example, how borrowing within a SMSF can benefit small business owners.
Dr Craig and Dr Sarah James, currently lease their business premises. They want to buy the premises but with their current home mortgage, they don’t have the available money to do so.
Dr Craig and Dr Sarah’s SMSF has a balance of $430,000. They are interested in how they can use some of these savings to purchase the premises (valued at $500,000).
Can their SMSF borrow?
In this example, one of the benefits of investing through their SMSF is that the doctors can use a portion of their existing superannuation balance as a deposit on the purchase of the business premises.
Banks may lend up to 80% for residential design premises value and 65% of commercial design premises value.
Dr Craig and Dr Sarah’s premises are located in a commercial building.
The SMSF could borrow $325,000 (65%) from the bank and use cash of $175,000 plus costs for their super fund to purchase the premises. Over time, the SMSF will use rental income, plus super contributions received from Dr Craig and Dr Sarah, to repay the debt to the bank.
The remainder of their SMSF balance is invested across other asset classes to meet their fund investment strategy.
Is it better to borrow personally if you can?
Property investors like the idea that any excess of expenses over the rent received can be deducted against other income.
Within the SMSF environment, the tax benefits of negative gearing are not so obvious. The excess deductions cannot be claimed by the individual members, only by the SMSF itself. This outcome should be weighed against the advantages of the SMSF borrowing, as well as having a sufficient deposit as noted above.
Like Dr Craig and Dr Sarah, the decision you make depends on your particular financial circumstances and arrangements. Always consult a qualified SMSF adviser to ensure your fund has the most appropriate structure and investments for your retirement.