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 help purchase investments such as direct property and shares. As with any SMSF investment, for this to be allowed, strict criteria must first be met.
Compliance is essential
The burgeoning growth in SMSFs combined with low interest rates has encouraged more SMSF owners to invest in property. Although these combined factors have made it more appealing, the need to comply with the borrowing rules is essential, 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 is armed with a range of powers including the imposition of administrative penalties and rectification and education orders against SMSF trustees.
How it might work
We will use a case study to demonstrate how this might work for small business owners.
Owners of CSJ Architects, Craig and 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.
Craig and 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); eliminating future rental payments whilst building up a sound asset in their fund.
Can their SMSF borrow?
In this example, one of the benefits of investing through their SMSF is that the couple can use a portion of their existing superannuation balance as a deposit on the purchase of the business premises.
On these types of loans, banks are not likely to lend up to 80% or 90% of the property value as with normal investment loans. The deposit is more likely to be around 60% to 65%.
Here, the SMSF has borrowed $200,000 from the bank to make up the difference between the James’ deposit of $300,000 (60%) from their super fund and the purchase price of the premises. Over time, the SMSF will use rental income, plus super contributions received from Craig and Sarah, to repay the debt to the bank.
The remainder of their SMSF balance is invested across other asset classes to meet their Fund’s investment strategy.
Is it better to borrow personally if you can?
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 fund itself. This outcome should be weighed against the advantages of SMSF borrowing, as well as having a sufficient deposit as noted above.
Like Craig and Sarah, the decision you make depends on your particular financial circumstances and arrangements. Don’t get caught up in all the marketing hype. Always consult a qualified SMSF adviser to ensure your fund has the most appropriate structure and investments for your retirement.