In a surprise move that comes earlier than expected, the Australian Tax Office (ATO) has released a breakthrough draft ruling that opens up new opportunities for SMSFs to improve their investment properties.
If passed, the ruling will also make super gearing arrangements more flexible by allowing borrowed funds to be used to complete purchases of off-the-plan property and to buy single assets built on multiple land titles. The draft rules also clarify under what circumstances super gearing can be used for asset repairs and maintenance. Prior to this ruling, many of these issues were unclear.
Super gearing is when a super fund borrows money and purchases an asset, which must be held in a special type of trust, often called a Holding Trust, for as long as the loan remains unpaid. Further details about super gearing can be found on the Switzer Super Report website under Borrowing and Lending with your SMSF.
Let’s take a look at the opportunities these draft rules open up for your SMSF.
Repairs, maintenance and improvements to assets
Under the current super laws, an asset in a Holding Trust can be repaired and maintained. However, it can’t be improved or replaced. This has limited the ability of many SMSF trustees to boost the value of their real estate investments.
But that could soon change with the clarification of what constitutes repairs, maintenance and improvements.
Under the draft rules, super funds can continue to use super gearing for repairs and maintenance. However, your SMSF still isn’t allowed to borrow money to renovate and improve the property. You can use existing funds within your SMSF to improve the asset, but the key here is that when making improvements, the asset must not be ‘replaced’ or ‘fundamentally changed’.
So while you can make improvements, SMSFs should still steer clear of the ‘renovator’s delight’.
The draft ruling provides some helpful examples of what will be allowed under the proposed changes:
- A super fund isn’t allowed to use super gearing to build an extension, such as an additional bathroom, for a property. This is considered to be an improvement.
- However, it is possible to purchase a property as part of a super gearing arrangement and repair it. The key is not to improve the asset to such an extent that the asset is not deemed to have been replaced.
- An SMSF can use existing funds to make improvements to a property, such as painting, new floorboards, new kitchen benches and new carpet.
- An SMSF can’t ‘fundamentally change’ a property by knocking it down and building a new one. Likewise, an SMSF can’t buy vacant land and build a structure upon it.
- If an asset is damaged or destroyed (due to fire, natural disasters and so on) then the draft ruling says the asset can be replaced like-for-like. For example, a three-bedroom house that is destroyed must only be replaced with another three-bedroom house.
The differences between repairs, maintenance and improvements can be highly complex. If in doubt, consider seeking good advice before proceeding.
An SMSF can buy a property off-the-plan by using existing funds to secure the purchase. Once the property has been built and strata titled, the super fund can then complete the purchase using a super gearing arrangement.
Real estate that involves more than one title
Ordinarily, only a single asset can be purchased using super gearing (unless the asset is part of a group of similar assets, like shares).
This creates an obvious problem for trustees who want to buy property that involves more than one land title. But the new draft ruling has made this rule more flexible by allowing trustees to buy real estate that involves more than one title if the assets can’t be dealt with separately. For example, your SMSF can now buy a large single-structure factory built over two land titles.
However, you can’t buy a bundle of property assets spread over multiple land titles if those assets could be split, such as two separate factories built on two separate land titles sold as one bundled estate.
Some important points to note:
- If passed, the draft ruling would only cover gearing arrangements put in place after 6 July 2010.
- The ‘draft’ may be changed or amended before it’s finalised.
Also in today’s Switzer Super Report
- Roger Montgomery: Are Myer and David Jones dead in the water?
- Peter Switzer: Is the vacation almost over for Europe?
- Paul Rickard: What deposit guarantee changes mean for term deposits