The rules of SMSF property investing

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Property investing within your self-managed super fund is a highly regulated affair and playing by the rules is essential if you are to avoid the perils and pitfalls of the property game. Follow these guidelines though, and you’ll discover that property investing in your SMSF can yield financial rewards.

Can I live in the property I buy with my SMSF?

When it comes to purchasing residential property inside your SMSF, one of the tightest rulings by the ATO is that the investment must be kept at “arms length”, restricting you from directly benefiting from the asset until retirement. (This is the same ruling that forces us to keep our artwork in storage until we retire, lest we gain pleasure from its aesthetics).

This means you can’t use your SMSF to purchase the home you live in, nor can you use it to purchase an investment for your family or lease it to anyone other than an unrelated third party.

Unfortunately, investing in a holiday home for yourself is also out, even if you only plan on staying there for one evening of the year.

What about commercial property? Can I invest my super in a business premises?

Yes you can. In fact, the ATO treats commercial property quite differently to residential investments, allowing you to indirectly benefit from the use of the property via your own business. For example, your super fund could potentially purchase the premises your business currently leases, allowing you to pay rent directly to your SMSF.

Many business owners have seen real benefit in acquiring a commercial property under this scheme as it essentially allows them to become their own long-term, blue-chip tenants.

What if I don’t have enough super to invest in property safely?

In my last article I talked about the ability to lend funds to your SMSF from an outside source, such as personal equity, in much the same way a bank lends money to its clients. The SMSF would then repay the loan back to you over an agreed time and at an agreed rate.

Alternatively, because an SMSF allows up to four members to act as trustees to the fund, you can effectively pool your assets with other parties to raise the monies required.

If my property increases in value, can I use the additional equity to buy more property?

The government has restricted the ability of SMSF’s to redraw on any additional equity gain that their investments may experience. This is one of the biggest considerations when it comes to investing in property as your equity gains are effectively “locked inside” the fund and can’t be leveraged in the same way as investments outside the fund.

Can I renovate to increase the properties value?

The ATO has been slowly relaxing its policies on SMSF property improvements over the last couple of years and it’s now possible to repair and even renovate and improve the property to add value. The difference lies in how the building works are financed and it is important to understand the difference between “repair” and “improve” if you are to avoid any liability.

According to the ATO, “’maintaining’ ordinarily means work done to prevent defects, damage or deterioration of an asset, or in anticipation of future defects, damage or deterioration, provided that the work merely ensures the continued functioning of the asset in its present state. The term ‘repairing’ ordinarily means remedying or making good defects in, damage to, or deterioration of an asset and contemplates the continued existence of the asset.”

This can be surmised as general wear and tear on the building. For this work, the SMSF can use its own funds or it can borrow the required funds to get the work done.

“In contrast to repair, an asset is improved if the state or function of the asset is significantly altered for the better, through substantial alterations, or the addition of further substantial features or rights, to the asset.”

This might include adding a pool or a granny flat or upgrading the kitchen.

In these cases, the SMSF can ONLY use existing funds – not borrowed – or funds from external sources to finance the improvements.

Can I develop the property I have purchased with my SMSF?

Each case would need to be evaluated on its own merits, however as an over-arching rule the SMSF property must remain the “same asset”. This means you can’t buy a vacant block of land then put a house on it, you can’t convert a house to a restaurant, and you can’t pull a house down and build three townhouses in its place.

Also, the property must only be purchased with a single title. You can’t purchase two properties in a single sale if they are on separate titles.

As you can see, purchasing property with your SMSF does have some restrictions and it’s essential that you understand these limitations as penalties can be fierce. Legislation is often changing to accommodate this growing investment strategy and there are always areas open for interpretation, so make sure you obtain timely advice that is specific to your situation if you intend to invest in property with your SMSF.

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.

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