There is a way to develop property using your self-managed super fund (SMSF) that doesn’t limit you to the restrictions of a limited recourse borrowing arrangement (LRBA). It’s called a ‘13.22 trust’, a unit trust that can be used to borrow and invest in assets, like property.
You can read over the 13.22 trust rules discussed last week in: Developing property with a unit trust.
Why use a 13.22?
Recall that an LRBA prevents SMSFs from using borrowed funds to make significant changes to an asset. To do that, you would need to use existing funds from within the SMSF, or you could borrow and use a 13.22 trust.
There are several purposes to using this type of trust: it enables a super fund to purchase a property sooner than might ordinarily be the case because it’s a ‘part’ investor with another party, such as yourself; it enables the investor to pay off debt using their tax deductible super contributions; and the unit trust can also own property that can be developed or improved.
Here, as promised last week, I’m going to provide an example of how to correctly use this strategy.
How a 13.22 trust works
Let’s say you personally invest in a private unit trust (this is your ‘13.22 trust’) and for this, you’ve chosen to use borrowed money. Your SMSF also invests in the same unit trust. The percentages you and your super fund hold in the trust will depend on your circumstances. The unit trust then uses the funds to purchases an asset, which in this case is an investment property.
Your personal borrowings are used to earn income – paid via distributions from the net rental income earned by the unit trust – and therefore the interest costs and other expenses associated with the investment would probably be tax deductible (you should speak to your accountant about your own circumstance).
Over the following years, you direct your superannuation contributions into your SMSF. The SMSF trustee uses these new contributions to buy more units in the unit trust.
Each year you request a part redemption of some of your unitholdings and use the proceeds to repay your personal debt (the unit trust has money for these redemptions because of your super contributions).
The objective is to eventually make your super fund the only unitholder in the 13.22 trust, so if the property was sold, the capital gain would be taxed at the concessional tax rates that apply to super funds.
Getting it right
With this strategy, it’s very easy to make a mistake at some stage through a lack of vigilance by anyone involved in administering it. It’s vital your 13.22 trust and your super fund follow all the rules I detailed last week.
From a superannuation legislation point of view, there are at least six other issues that have to be addressed:
1) Your SMSF can’t invest in anything unless its investment strategy allows that investment;
2) Your super fund’s trust deed must also allow the investment;
3) A specific super law doesn’t allow your super fund to loan money or provide any financial assistance to its members or the member’s relatives. This means the property held in the unit trust can’t be held as a security for your personal borrowings. The units you own in the unit trust also can’t be used as security. You will have to use another asset as security.
4) There must be an agreement in place between the SMSF and you stating that you’ll only deal with your unitholding in such a way that won’t cause the SMSF to lose access to tax concessions or cause the trustee to breach any super laws.
5) You might be tempted to use this strategy to transfer a property you already personally own into the unit trust and have your SMSF purchase units in that trust. This can only happen with business real property – that is, property used wholly and exclusively in the running of at least one business.
6) The sole purpose test – you must run your super fund only for the purposes allowed by the super laws. The main purpose of running a super fund must be to provide retirement benefits for the fund’s members. Would this arrangement be deemed to be an elaborate arrangement to channel superannuation contributions into private hands?
Using a 13.22 trust to buy a property is a great strategy, but you have to be careful at all times. Unfortunately for some, the lower concessional contribution caps mean this strategy has lost some of its shine because the caps may limit the ability to pay the loan off faster.
When working out if it’s a good strategy for you, don’t forget to factor in the costs of administering the unit trust.
Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Anyone should consider the appropriateness of the information in regards to their circumstances.