There’s no doubt that using super gearing to buy property is becoming very popular.
The reasons for this popularity are clear: Australian investors have great faith in property as a wealth creation investment and, at long last, we’re able to use the money stored in our super to buy it while using our preferred purchase method – leverage. Add to that the tax advantages, and you’ve got a pretty attractive proposition.
Super gearing, which is now officially called a ‘limited recourse borrowing arrangement’, is when an SMSF borrows money to purchase an asset. While the loan is outstanding, the asset must be held in a special type of trust usually called a ‘holding trust’.
The strategy can be a great way for small businesses to purchase their business premises.
There have been several variations of the gearing rules over time. The current rules apply to super gearing arrangements that have been finalised after 6 July 2010. Let’s focus on these.
Before embarking on this investment structure, it’s essential to make sure your trust deed allows your SMSF to borrow money (many older trust deeds don’t allow this practise.) Your SMSF can borrow the money from anyone, including the members of the fund. However, if the lender is ‘related’ to the fund, you must satisfy the ‘arm’s length rule’, which effectively means the lender must charge the same interest rate as the commercial banks. If the lender is a related discretionary trust with a corporation as a beneficiary or if the lender is a corporation, there are some important tax rules to consider. You should talk these over with your accountant.
When performing a credit assessment on you and your super fund, some banks will take into account your SMSF’s contribution history (that is, the regular contributions you or your employer make) as well as the income from your super fund’s other assets, (such as dividend income from shares).
A major advantage of buying an asset through your SMSF is that it may be better protected from creditors in the event of bankruptcy or insolvency.
Like all investment structures, there are some disadvantages. Here’s a brief list of some of them that apply to super gearing arrangements:
You or your relatives can’t use the asset: if the asset is a residential property, then you or your relatives can’t use that property. This rule doesn’t apply to business property.
The structure is complex: it’s fairly easy to make an innocent error that could land you in trouble.
Extra expenses: the complexity of the structure adds to the cost of purchasing property and it will increase the cost of administering and auditing your fund.
Over-leveraging: there’s no limit on the amount you can borrow in this arrangement (although most banks seems to lend between 60% and 80% of the asset’s value). Keep the safety of your SMSF in mind when borrowing to avoid over-leveraging.
Double ad valorem stamp duty: if you make a mistake in structuring the purchase or the order in which you complete the relevant documents, you may have to pay ad valorem stamp duty more than once.
Lender requirements: some lenders have demanded that loan documentation and SMSF trust deeds include certain provisions that breach super law. Make sure the documents are carefully vetted by a lawyer to avoid trouble.
Super gearing can be a great way to boost the value of your SMSF. However, I think it’s important to do a lot of research before using this strategy. Ask yourself: is the property a good investment? Would you buy it without the tax concessions? Are you borrowing too much money and could your SMSF afford it if interest rates were to spike upwards or you can’t find someone to rent the property? And do you understand all the fine print?
If the answer to all those questions is ‘yes’, then, happy investing!
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. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.
