Changes to superannuation legislation now allows an SMSF to borrow funds for property investment. If you have an SMSF, you may now be able to borrow money to buy a commercial or residential property through your SMSF.
Limited recourse SMSF borrowing arrangement
If the SMSF has enough funds for a deposit, the remainder of the purchase price can be borrowed. The SMSF can either borrow from a financial institution e.g. a bank or credit union or from the Members.
Lending is done with non-recourse borrowing arrangements. This means the lender does not have a recourse or right on other assets in the SMSF. For this reason the lender (bank) will ask the Members for a guarantee. This arrangement is generally referred to as a limited recourse borrowing arrangement.
The SMSF provides the funds for a partial payment of the property and also pays all the relevant fees. The SMSF will borrow to settle the balance.
Where a bigger deposit is paid by the SMSF on the investment property, the bank may not ask for security from the Trustees. The property will be the sole security for the loan under this limited recourse loan agreement. In the event of default, the lender only has a recourse on the property. The lender can never claim against other assets within the SMSF.
As a general rule-of-thumb, a bank will borrow 80% on residential property and ask for a guarantee from the trustees, or won’t ask for a guarantee at 60% loan rates. The benchmarks on commercial property are 70% and 50% respectively. Factors the bank will assess are property quality, credit history and rental income in assessing the need for a guarantee.
The investment property is owned by the bare trust with the SMSF having a beneficial entitlement to it. The bare trust is merely the holder of the title until the loan is paid off. The SMSF will receive lease payments from the lessee and will expense the interest paid on the SMSF loan.
After the loan is repaid the SMSF has the right, but not the obligation, to acquire the legal ownership of the investment property.
When purchasing a residential property, the SMSF can not have any dealings with a related party. This means you can not sell your house to the SMSF. The Fund can also not rent the property to a Trustee, a family member of mother in law. You can, however, purchase the property from the SMSF when entering the pension phase.
When lending to an SMSF, Trustees need to ensure that terms of lending are on an arms length basis and issued on commercial terms. The Tax Office has recently published a practical compliance guidance (PCG 2016/5) which sets out the recommended interest rate and loan terms for a related party loan to the SMSF. This is known as the Safe Harbour Provision.
Safe Harbour Provision
For SMSF Trustees with Limited Recourse Borrowing Arrangements (LRBAs), the Commissioner may not accept the arrangement to be at arms length as there is no certainty provided. For more information, see the link below:
Please note a sample loan repaymet schedule here.
Benefits of purchasing property in your SMSF
- commercial property owned by you can be sold at the SMSF at market rates;
- assets in the SMSF are secure as the lender only has a recourse on the investment property, plus any additional security provided by the guarantor;
- the loan is paid off by using super contributions and rental income;
- the SMSF is only taxed at the net income after loan interest and expenses are deducted against the rental income;
- the SMSF is only taxed at a rate of 15% compared to marginal rates if the property was purchased in a personal capacity; and
- capital gains will only be taxed at a rate of between 0% – 15%.
Things to consider
- the SMSF needs to be established before the bare trust and corporate trustee are established;
- the bare trust and corporate trustee are mere title holders of the property and all transactions will occur within the SMSF;
- the trust deed provided by Superannuation Warehouse will allow for borrowing;
- the investment strategy of the SMSF should allow for property investment;
- the SMSF will require sufficient cash flows to service the loan. This can come from rental incomes, investment earnings and member contributions;
- all transactions incurred must be at arms length and at market rates; and
- do not consider buying a holiday property in your SMSF and then using it.
All investments purchases should serve the sole purpose test.
Bank and Broker Information
You are free to use any bank or lender when arranging finance for your SMSF property purchase. To get the best deal possible, you’d be well advised to use a mortgage broker. You can use a big bank or one of the niche players like Macquarie who, by the way, have a very informative free brochure with some great examples. You can also download a cash flow analysis brochure here which gives examples on the cash flow details of an property with a limited recourse borrowing arrangement in place.
Trustees can contact John Gregory from Money Quest Finance Specialist for more information. Their contact details are noted below:
John Gregory (Money Quest Finance Specialist)
p: 0400 830 138
ATO Guidance on Borrowing
The ATO issued a ruling on borrowing. This is set out in the link below.
To send us the property details to set up us Bare Trust, click here to see the info we need.