FINALLY, YOUR SUPER CAN WORK WITH DIRECT PROPERTY AT GEARING LEVELS

Until the last week of September 2007 Self Managed Superannuation Funds (SMSF’s) could not borrow to invest into property, but now the law has changed to allow SMSF’s to borrow as long it’s via what’s called an instalment warrant, which is internally geared.

Why Buy Geared Property in Super?

1. Benefit from Tax Efficiency

There is a maximum of 10% capital gains tax on sale of property if held for at least 12 months & potentially nil if sold in pension phase. There is a maximum of 15% tax on rental income. Also, you may effectively receive a tax deduction for principal repayments via a salary sacrifice arrangement which you cannot normally do. The interest cost of the warrants is tax deductible which reduces the 15% contributions tax of SMSF’s. Retirement is very tax effective in that if you are over 60 there is no tax on withdrawals or pension earnings.

2. Affordability

A benefit of borrowing in super is that potentially you can afford to borrow more as the servicing on the loan can be funded not only from tenant rental payments but also from Employer’s compulsory 9% super contributions, Salary sacrifice contributions, Personal Contributions and the Government Co-Contribution, up to $1,000 per annum.

3. Super is Now Simpler & More Flexible

There is now no restriction on how much you can withdraw in retirement and no requirement to withdraw any funds until age 75.

4. Gearing helps Overcome the Super Contribution Cap limits

Given the huge tax breaks and flexibility super now offers, the government is capping how much you can contribute. Personal Contributions are limited to $150,000 p.a. or $450,000 over 3 years and tax deductible contributions are limited to $25,000 p.a. (under 50 years of age). By building a geared property portfolio inside super you can maximise your super benefits by allowing you to get more money into the tax effective system of super.

5. Your personal borrowing capacity is not affected

As the loan is taken out within superannuation it is not recorded as a liability against your name and therefore your borrowing capacity for investing or business interests outside super are not affected.

6. Reduced Risk

A key feature of instalment warrants is that the funds are advanced on a limited recourse basis, this means the only amount you stand to lose is your original deposit protecting your other assets from creditors including any other investments in your SMSF portfolio.

How Does it work?

Firstly you will need to have a complying SMSF with at least $120,000 total account balance. You then find the property based on normal lenders valuations. The SMSF makes the first instalment of 30% deposit plus stamp duty/ legal costs plus the first year’s interest repayment. The balance of the purchase price of the property is made up by a limited recourse loan. The property is held on trust until the final instalment is made or the property is sold. The SMSF then receives all income and capital growth while paying all the interest and associated costs.

Risks to Consider

However, although there are great tax benefits and an opportunity to leverage into direct property the following risks need to be considered:

• Investment Risk – Whilst borrowing to invest can magnify your returns it can also magnify your losses if the investment makes a negative return.
• Loan Structure - For various reasons an ordinary home loan will not be allowed under the new rules and as such it is imperative that you seek professional advice from a qualified adviser when structuring your finance within super.
• Cash Flow – If the property is negatively geared, you need to ensure that the super fund has adequate cash flow to meet interest payments. Apart from the investment property rent a great source of cash inflow are super contributions such as the compulsory 9% employer super contribution.
• Legislative Risk – Of course the law can always change to prohibit borrowing in super, but generally when super law changes they provide existing investors with some exemptions.
• Preservation – Don’t forget that you cannot access your superannuation until you meet a condition of release, which for most people is being over 55 and semi retired.
• Super Rules – Apart from your commercial property you cannot buy existing property from yourself or your relatives and you cannot live in the property or use it for your own enjoyment e.g. holiday house.

For the savvy property investor, the new changes provide a huge opportunity granting them great access to capital to diversify their super into direct property in an extremely tax effective way. However, as with everything there are a few simple rules you need to be aware of.

Contact Pat or Alysha with any further queries or to set up a consultation.

Tagged as: direct property, smsf, smsf borrow, SMSF loans, super, super contribution, super contributions