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In last week’s Hudson Report, my colleague made mention of some recent headlines relating to the government taking another long hard look at superannuation as a source of revenue. Specifically they have been honing in somewhat on self-managed superannuation funds (SMSFs) and one area of focus has been the current ability to potentially avoid capital gains on property that is transferred or purchased within them. As such I thought it was worth revisiting the implications of buying property under a SMSF.
As you are probably aware, new laws introduced in both 2007 and 2010 have opened up the ability to borrow within a SMSF to fund the purchase of both commercial and residential property. This strategy has fast become the “flavour of the month” and many financial planners (and accountants) have been eager to jump on the bandwagon. Although I believe there is a place for property within super, you should bear in mind the following if you are giving it serious consideration:
- Borrowing rates and restrictions: Borrowing under your SMSF must be done via a limited recourse borrowing arrangement, meaning you are required you to set up a “bare trust”, which is an added cost. Depending on the lender, the amount you can borrow is usually capped at 70% (possibly 80% if there is a corporate trustee). The cost of borrowing is generally higher as most lenders will not provide any discount off the standard variable rates, so you will likely be looking at around 0.6% to 1% more than borrowing in your own name.
- Taxation considerations: The costs associated cannot be deducted from your personal income, even if you are self-employed, so you do not have the same gearing potential as you do outside of super. There is a maximum deduction rate of 15c in the dollar, as opposed to 34%, 38.5% or even 46.5% (inc. Medicare levy) for those on the highest marginal tax rate. The main advantage tax wise is the maximum capital gains tax of 10%. However, bear in mind that there is no 50% CGT discount as there is for individuals that hold an asset longer than 12 months. So although outside of super you may pay capital gains at your marginal tax rate of 34%, this is effectively only 17% given the discount. If sold in pension phase under current rules there is nil CGT, but as per my colleagues article last week, there is no guarantee the current or future governments will maintain these rules.
- Regulatory restrictions: Like any asset held under a SMSF, there are “arms length” restrictions, meaning you cannot choose to live in your investment property at any stage, nor rent/lease it to a related party. If you are planning to move into the property once it’s paid off (e.g. a retirement home or an apartment on the beach) bear in mind you will need to purchase the property from the SMSF at market value and that there will be taxation implications and costs such as stamp duty to pay.
- Diversification considerations: Although not a concern for those with larger super balances, for those with a balance anywhere near or under $300k, a property purchase may well become all the eggs in your retirement basket. One asset, in one location, reliant on one growth factor.
Having reflected on all of the above it sounds as though buying property under a SMSF works out well for the property developer selling you the property, the bank who charges you more interest to borrow and your accountant who charges you to set up your SMSF, the bare trust, ongoing audits, etc. But is it truly as attractive for the individual as many people are currently making out?
Despite the above, as I have stated, I do believe there is a place for property in super, but the scenario seems to be a rare one. This would be those with a large enough balance that a property purchase would constitute an absolute maximum of 50% of their overall asset base. However, it would also need to be an individual that does not have a high taxable income, so as to limit the advantages of holding the property outside of their SMSF. There could also be a case for the self-employed to hold commercial property under their SMSF. However, this seems to be at odds with the fact that commercial property tends to be high income/low growth and the main advantage of property under a SMSF is the low capital gains tax on the growth that’s experienced.
For most of us, considering the above restrictions and combined with the potential for a change in current superannuation taxation laws, I’m of the belief that this particular flavour of the month may be short-lived or that it is only for limited use for certain individuals.