Self Managed Super Wealth Day

Super rules for many investors at the moment.

Those with a self-managed super fund (SMSF) are quickly discovering it can be an exciting way to increase a property portfolio and also help create super wealth.super

Mix a new pad, with tax benefits, and it’s easy to see why the word ‘SMSF’ is the new ‘sexy’, according to Adelaide-based Mortgage 123 broker and property expert Les Harris.

“It’s very sexy, a self-managed super fund (SMSF), because I’m old,” Harris jokes. “At a young age, it’s not too sexy.”

The main reason super rules and is considered ‘sexy’ by so many is because of the policies around capital gains tax when you’re in pension phase.

For people like Harris, who happens to turn 60 next year, they’re able to access funds from within their SMSF and pay absolutely zero tax if they sell a property at a later date, provided they’re in pension phase.

There’s also the lure of being able to be in charge of your own future.

money save coin

Harris is a big fan of SMSF and says the fact he can buy property where he wants, when he wants and exactly what he wants is a big draw card.

“The appeal right now is people feel they have more control,” he explains. “If you prefer property to shares, you can move money into a SMSF and help reduce the debt quickly. The more money you have in a super fund, the more quickly you can pay debt off.”

And it appears Harris isn’t alone. Self-managed super funds are now the largest and fastest growing segment of the super industry.

There were 528,700 SMSF’s with one million members as of June this year, compared to 271,000 SMSF’s 10 years ago, according to research firm CoreData.

This represents almost a third of Australia’s total $1.6 trillion super pool.

Chan and Naylor managing director Ken Raiss says the reason its popularity is increasing is because it’s a tax free heaven in the pension stage, if set-up and structured correctly.

Mum and Dad investors love it, but so do those with multimillion-dollar portfolios and even the most respected brokers and accountants.

“Personally, I love it, because you’re in control and it’s a tax-free environment when you’re in retirement,” Raiss says.

What is a SMSF?

The difference between a SMSF and a superannuation fund is that you’re the trustee of the SMSF and you run it for your own benefit in retirement.

Of course, superannuation is also for your own benefit in retirement, but the thinking behind a SMSF is that you have more control with what you do with the finances.

[sam id=50 codes=’true’]

If you’re keen to purchase a property using a SMSF but need a loan, you actually need to purchase the property within what’s called a holding trust, also known as a bare trust.

Raiss says it’s simply part of legislation. If there’s going to be a purchase with debt, the asset can’t be held directly in the super fund,” he says.

“The loan is called a LRBA – limited recourse borrowing arrangement.”

It sounds complex and scary but it’s actually a way of protecting you, according to Raiss.

“What it means is that if you default on the loan, the person lending you money can only attack and take the asset they loaned you the money for,” Raiss explains.

If you’re thinking of trying to purchase a property using a SMSF, Rate Detective Finance managing director Warren Dworcan believes the sooner, the better.

“It’s recommended you do so as early as possible from your planned retirement, as you have a steady cash flow to deal with any tenant problems,” he says.

“This also allows the property a greater opportunity to grow, making sure you can take full advantage of the tax benefits, so you can live your latter years doing what you always dreamed of.”

The Australian Tax Office (ATO) requires annual audits of SMSF’s and so managing your own fund and getting it right is very important.

There are a lot of regulations that are designed to protect your super and your retirement income. Let’s discover why you have to be super careful when it comes to your superannuation and look at the 10 not-so-super, and 10 super, rules.

 10 not-so-super rules

1. Big set up costs

Buying property always comes with big entry and exit costs. Add a SMSF into the mix and the fees are even more expensive.

SMSF - The Power of Super - Superman Picture Feb 2012

You have to consider legal fees, advices fees, bank fees and set-up fees and always check with your accountant first.

“It probably costs about $2500 to set it up but then there are ongoing expenses, because you need an accountant, plus the SMSF gets audited each year,” Harris says.

“If you have an investment property, it also has to be valued every three years.”

If you’re using a holding trust to set up a loan through your SMSF, the set-up costs also incur expenses.

“You virtually have to set up a separate company, which is the owner of the property,” Harris says.

“That’s another cost and you have to pay that every year.”

2. You need a bigger deposit

Harris says most investors keen to purchase a property with a SMSF would need at least $100,000 as an absolute minimum.

In many cases, $150,000 or $200,000 is considered the norm.coin house money tax

“One of the banks I deal with expects you to have more than $250,000 before they’ll look at it. Other lenders don’t care, as long as you have enough money to meet repayments,” he says

Justin Beeton of the SMSF Club believes you also need a buffer of $50,000 to ride out any downturns or problems.

Raiss adds that more banks are now providing up to 80 per cent loans – you simply need to come up with the 20 per cent deposit for the purchase.

But add in entry costs and stamp duty, and you’re likely to need about 30 per cent of the purchase price.

”The banks also require a financial planner’s sign off to demonstrate that you have sought financial advice and that this purchase fits within your strategy.” he says.

“Now, some of the banks insist you go to their own financial planner and that can cost up to $3000.”

However, Raiss warns you should never give a bank control.

“There are a couple of lenders that want to put their own corporate trustee on the holding trust.” he says.

“It’s not as bad as it sounds but it means you have to go back to them every time you want to do something. Some banks are now insisting that if you want a loan from them, then this is how it has to be. Therefore, you want to make sure that you choose a lender where you can have your own trustee and seek you own independent financial advice.”

3. Interest rates are higher in a SMSF 

Banks will always charge a higher interest rate for a SMSF.high interest rates

Raiss says they usually have their own standard variable rate, and then other rates with a discount of 0.5 per cent or 0.7 per cent and sometimes even one per cent.

With a SMSF, or holding trust, this will never happen.

“Banks will tell you that they have to charge more interest because of the LRBA,” Raiss says.

“But nine times out of 10 they have a personal guarantee from you, so it’s just banks being banks.”

A SMSF loan also takes a little longer to process, simply because there’s usually more paperwork involved.

4. No relatives

A property bought through a SMSF has to meet the ‘sole purpose test’.

This means it must be purchased to help fund your retirement income and can’t be bought from you or a relative. You can’t live in your new digs and you can’t rent it out to either yourself or relatives.

It’s what property expert and author Miriam Sandkuhler of Property Mavens describes as ‘an arm’s length’ requirement.

“You can’t buy property and use it as a holiday home,” she says.

“You or your family members mustn’t get any personal benefit from the property. You can’t do anything that puts ‘an arm’s length’ classification at risk, or you risk making your superfund non-compliant. The consequences of your fund being non-compliant are severe.

5. No negative gearing

If you love blue-chip properties and don’t mind negatively gearing while you wait for capital growth, you’re probably likely to face some shortfalls over the first few years.

However, negatively gearing is extremely difficult and not worthwhile within a SMSF, according to Dworcan.

interest rates not encouraging home buyers

“Losses are offset against other super fund income but the maximum tax rate is only 15 per cent,” he says.

“It would make a bigger difference for your personal income, which could be taxed as high as 45 per cent (depending on your personal income).

“However, if you’re currently contributing less than your allowable limits into your SMSF, you can salary sacrifice extra to fund the negative gearing, which is the same tax benefit if purchased outside super.

“Secondly, with the tight rulings on improvements, it can be difficult to increase the income generated to transform it to positively geared property. Lastly, with the generous tax rate on income, negative gearing may be a wasted opportunity, so the incentive should be to try and make a profit on rent.”

Harris adds expenses for a SMSF property must be made within the SMSF.”

“The actual investment itself is a standalone investment and the SMSF has to be able to pay for the repayments, based on the income generated through the SMSF,” Harris adds.

Dworcan says this means loan repayments have to be made from your SMSF property.

If you don’t have the necessary cash reserves, you could be in trouble if your tenant stops paying rent,” he says.

“This becomes even more relevant once retired, as you’re no longer earning a steady income.”

But don’t forget that while you’re working, your employer would also be putting money, as super, into your SMSF each week, through your normal salary.

This amount should be around 9.5 per cent of your annual usage. It would also contribute towards holding costs.

For example, if two people have a SMSF and earn $100,000 combined, about $9,500 would be going into the SMSF each year.

“That amount plus the rent from the property, has to be enough to service the debt or you won’t be able to borrow,” Harris explains.

6. Complex structure

Most people think you buy property through a SMSF, but you actually purchase property in a holding trust, as part of a SMSF.

The entire fund needs to be set up by an accountant.real estate client

Author of Building wealth in a “self-managed superfund and property millionaire Coral Brian-Wheatley likes to call each of her trusts the street name of the property.

“If we buy a property in Victoria Street, we’ll call it the Victoria Street trust,” she says.

“It’s a piece of paper that states the property is in a trust, but it’s run through the SMSF.

All the rent goes into the SMSF and repairs and maintenance get paid from the SMSF. It’s important that the accountant sets it up in the right names.”

Like Raiss, she believes trusts should always be set up as a corporate trust, rather than an individual trust.

“If someone passes away (in an individual trust) you have to sell. In a corporate trust, it just gets passed to the next person. It initially costs more to set up a corporate trust but it far outweighs an individual trust.”

7. Super spruikers

Sandkuhler warns those planning to purchase a property through a SMSF should avoid ‘one stop shops’. If a developer is trying to sell property and promising they can also take care of your SMSF paperwork, it might be a red flag, she says.

“They flog poor performing property for their vendor, rather than offering what’s best for the buyer,” she says.

“They’re unlawfully providing investment advice they’re not qualified to give. If anyone suggests you should set up a SMSF to buy properties as a means of them selling their stock to you, you should be very wary. If you feel manipulated, report them to the Australian Securities and Investments Commission (ASIC).”

8.  No get out of jail free card

A SMSF is hard to cancel.

If the property loan documentation and contract isn’t set up correctly, unwinding the arrangement might not be allowed and you might be required to sell the property.

This would obviously cause a substantial loss to the SMSF.get out of jail free card

Raiss says getting out of a SMSF is always hard, simply because of the way it’s set up in the beginning.

“Every member of a SMSF must be a trustee,” he explains.

“If it’s a corporate trustee (the preferred option), every member must be a director.”

This means a SMSF has to be split with the allocation of members’ funds.

“Whatever your dollar value is, it’s yours,” he says.

“If you want to leave, you have to be able to extract your members balance. If there’s not a sufficient number of other assets in shares or cash and one person wants to leave, people are effectively forced to sell a property.” On top of that, any tax losses from the property can’t be offset against your taxable income outside the fund. So getting the structure right from the beginning is imperative and a SMSF should be seen as a long-term strategy for building super wealth.

9. No renovating, developing or subdividing with a SMSF loan

You can’t actually borrow, buy and ‘improve’ a property if it’s in a SMSF and there’s a loan on the property.

That means you can’t borrow for improvements, you can only maintain the property. In some cases a cosmetic renovation, (replacing what was there before), can be funded with borrowed money.

InDesign-Blog-Post-Home-Reno

You also can’t develop or subdivide if you have a property in a holding trust, (if you have a loan against the property), Raiss adds.

In fact, it’s pretty much a big ‘no-no’ to do anything other than hold the property long-term.

Dworcan says the reason you can only hold a property, rather than renovate it, is because of the LRBA structure.

“The ATO has strict rules on what qualifies under LRBA.” Dworcan says.

“If it doesn’t meet the requirements it can still potentially be done, however, it must be funded using cash in the SMSF. Therefore, bank policies are aligned with LRBA rules.”

Dworcan adds repairs and maintenance of the property are allowed but improvements aren’t.

“You can borrow funds for repairs, but not for an extension,” he says.

You can also borrow funds to retain the asset’s identity, but any changes that result in a different asset aren’t acceptable.

“For example, the original asset is a block of land. By subdividing it, the identity of the asset has changed,” Dworcan says.

“The same applies if you build a house. Therefore, it can’t qualify under LRBA.”

However, if the land was originally purchased using cash, then it’s not bound by a LRBA and construction can be done using the SMSF’s cash, he says.

“Another example is an option to buy a house,” Dworcan adds.200319384-001

“It can be sold to another part as an option, but the option itself can’t be realised by a SMSF, as it changes the identity of the asset, from an option into actual property.”

While you can’t buy a block of land, then build, you can purchase a house-and-land package.

If the property was originally presented as a house-and-land package, then its one single asset and the identity of it is as a house on land,” Dworcan says.

A subdivision or development would also change the identity of the asset and no longer comply with LRBA rules.

“Therefore, it can’t be financed and requires a lot of capital in SMSF,” Dworcan says.

“You can be deemed as running a business as a developer out of your SMSF. This could result in loss of tax concession.”

10. No leveraging of equity

If the property you own through a SMSF grows in value, forget about utilising the equity to borrow and build a portfolio. For investors, this is potentially the biggest con.

“If you buy a property for $400,000 and the loan is $300,000 and the property increases to the value of $600,000, you can’t refinance or increase the loan above $300, 000,” Beeton says.

“You can buy two properties with new super you’ve gained, but you can’t use the equity to buy two properties.”

Raiss believes this rule makes buying property through a SMSF not worthwhile for many beginner investors.

“For your first one or two properties, it might not be a good idea,” he says.

 

 6 super rules

1. Tax benefits

The biggest advantage when it comes to buying property through a SMSF is the beautiful tax concessions.

SMSFs are subjected to income tax but it’s at a much lower rate of just 15 per cent.tax_return_360_18s4kr3-18s4ksi

“If you individually earn more than $80,000, you’ll be taxed 38.5 cents in the dollar, but with a super fund it’s taxed at just 15 cents (in the dollar),” Harris says.

Dworcan says the capital gains tax rate is reduced to just 10 per cent for assets held for 12 months and it’s eliminated once you’re in the ‘pension phase’.

“It can save you tens of thousands, even hundreds of thousands, in tax,” Dworcan says.

“It’s a similar story for rental income, with 15 per cent tax being the maximum and none at all during pension phase.”

Beeton says you can essentially purchase a property in a SMSF when you’re 50, then sell it tax-free when you’re in ‘pension phase’ at 60 (provided you have actually retired).

“A SMSF can sell at any time, however, profits go back into the SMSF, which can only be drawn once members reach preservation/retirement age. If you were born before July 1, 1960, that age is 55 and anyone born after July 1, 1964, has a preservation age of 60, with the ages progressively increasing by a year for the period in between.”

Brian-Wheatley says it’s also possible to use an existing portfolio outside a SMSF to reduce tax.

“When we sell properties outside a fund we have a capital gain, but to reduce capital gains tax, we could contribute more to our SMSF,” Brian-Wheatley says.

Taxes“If you retire and you’re in pension phase you pay nothing (in tax when you sell through a SMSF). If you aren’t yet in pension phase, you only pay 10 per cent.”

However, the rules can vary and depend on each individual’s circumstances, so always see an accountant or qualified adviser first.

Raiss adds buying property in a SMSF has enormous tax benefits for those who are getting closer to retirement and don’t yet have a property portfolio.

“Some people can’t buy outside super (because they don’t have enough cash for a deposit) but they might have a lot of super. The bank also takes into account the 9.5 per cent super guarantee (from an employer). In this case, buying in super means you have a long-term asset that will grow and be tax free in the pension stage,” he explains, adding that you can then sell it tax free and pay down the debt. It’s also possible to claim depreciation through a SMSF, should you purchase a unit off the plan through a super fund, although there are some rules, Raiss says.

“The depreciation schedule must be prepared by a quantity surveyor and preferably one who specializes in this are,” Raiss explains.

“Schedules produced by, say, the developer or builder, aren’t acceptable by the ATO. When looking at apartments, the state where the property is and the type of title are important. In some cases, you can’t depreciate the value within common areas, so check carefully. Other areas for special attention include furniture packs and low-cost and low value pool items. If the property is commercial there may be an opportunity to claim under the simplified depreciation rules for small business entities.

2. You pay yourself twice

If you have to negatively gear a property within a SMSF, you can pay yourself twice. Sound too good to be true? It isn’t! You can salary sacrifice and get a tax benefit while working, while also using the money to cover holding costs for the property in your SMSF.

payBrian-Wheatley says most people don’t understand how the ATO actually gives you money back if you put money into your super fund first. The amount you can contribute to your super fund will depend on your age.

“If you pay yourself first through making contributions, you’d be taxed on that money anyway,” she says.

“You can’t afford not to (pay yourself first through salary sacrificing into your super account) because you don’t have that money anyway. By contributing to the maximum amount you’re able to in a super fund, you’re able to leverage your super fund and also reward yourself.”

For example, Harris explains you can salary sacrifice up to $35,000, depending on your age, and you’ll be charged at a lower tax rate. In other words, if you earn $100,000 a year and put $35,000 in your SMSF, you’ll be charged at a tax rate as if you were earning $65,000.

Using that $35,000 in your super fund, you can then pay down debt owed on your SMSF property.

“You’re getting a tax deduction to put money in and you’re actually using that money to pay down debt,” Sandkuhler adds.

3. Small business bonus 

While you might not be allowed to live in your own residential property, you can rent out a commercial property you own to your own business. So for those who own a small business, it’s a nice bonus.

“Your SMSF could potentially purchase your business premises, allowing you to pay rent directly to your SMSF at the market rate.” ASIC says.

Brian-Wheatley adds it’s important to have good leases in place, if you do decide to purchase a commercial property through a SMSF.

“If you move out, you have to be able to rent it for that amount of money,” she says.

“Watch out for people promising big bucks. It doesn’t happen.”

4. Forced savings 

If you own a SMSF, you’ll only be able to gain access to you super when you reach ‘preservation age’ and meet one of the specified conditions for release, such as retirement.saving

“There are very limited circumstances, such as death or a terminal medical condition, where a member’s super can be accessed before this,’ the ATO says.

“There are significant penalties for unlawfully releasing super benefits.” In a way, it’s a good thing. It’s forcing you to save for later in life. In a world of instant gratification, it could guarantee you have money when you’ll need it most.

However, Brian-Wheatley says it’s important to understand that money in a SMSF is completely different to money in your personal bank account.

“It’s like a bubble and you can’t touch that money in the bubble,” she says.

“If you take money out before then, you’ll lose, because you’ll pay (up to) 48 cents in the dollar. Whatever you build within a SMSF can’t be used for holidays or instant gratification.”

5. Land tax threshold 

farm land countryProperties within a SMSF have their own land tax threshold. It varies from state to state but it could save you big bucks, if you already own numerous properties in your own personal name in one particular state.

“Even though the property is acquired by a holding trust, it still gets the threshold, either because it’s a super fund, or the state sees it as a fixed trust,” Raiss says.

Becton says if you already own a large number of properties, you might be able to save yourself thousands of dollars each year by purchasing through a SMSF.

“If you go over the threshold it could cost you a few thousand each year (and varies on a state-by-state basis).

If you purchase a property in a SMSF it means the tax threshold would change.”

6. You can consolidate 

If you have others in the family keen to build a portfolio, it’s possible to consolidate your money into a SMSF. You can have as many as four people – enough for you and your three favourite siblings.

“You can use what might have been ‘half-idle’ money and actually purchase property with other people in your family, as long as you all stay friends,” Raiss jokes.

Did you know? 

There aren’t just benefits with putting money into a SMSF. There are also benefits with taking money out.

In fact, it’s actually possible to cut down your working hours while maintaining the same level of income using a SMSF.super

Brian-Wheatley is a big fan of selling a property, then putting the money into a SMSF, and later taking it out through what’s known as a transition to retirement or TTR.

If you’re over 55 and you earn, say, $75,000 a year, it’s possible to cut back from 35 hours a week to just 25 hours, which would reduce your salary from $75,000 to $53,500.

By using the TTR strategy, you can maintain your after-tax income, despite reducing your working hours.

But it does come at a price – your super will dwindle over time as you continue to draw down your pension payments. However, this strategy isn’t for everyone. Brian-Wheatley says.

“I wouldn’t encourage anyone to take money out of their super, unless it wasn’t touching their capital and was only a rental, or they were investing in passive income assets outside their super fund,” she says.

“You don’t want your super fund dwindling at all.”

 

                                                                     Before                                            After

———————————————————————————————————

Salary                                                          $75,000                                         $53,500 

———————————————————————————————————–

TTR allocated pension                                  –                                                  $17,494

———————————————————————————————————–

Gross assessable income                         $75,000                                         $70,994

———————————————————————————————————–

Income tax                                                  $17,422                                         $13.416

———————————————————————————————————–

Take home pay                                           $57,578                                         $57,578

———————————————————————————————————–

 

You can work less hours

If you’re older than 55 and sell property within a SMSF, you might be able to draw money out using a transition to retirement (TTR) scheme.

WEEKEND-SUMMARYThis allows you to take money out and use it for whatever you want.

Brian-Wheatley has actually done a few developments with the help of a TTR.

She explains her husband was born before 1954, so he can draw out up to 10 per cent of money within their SMSF, as a TTR.

“We then use that money for developments in our NSW land tax unit trust,” she says.

See the breakout box above for more information, which shows how this complex rule could potentially go a long way to help you cut down your work hours.

However, like all things in a SMSF, make sure you always check with an accountant.

You have control 

Sandkuhler says the benefit of a SMSF is that you have more control over what happens to your retirement nest egg.

“You have the capacity to buy direct property and direct shares,” she says.decision puzzle

“The advantage and freedom of a super fund is that it puts the trustee in the driving seat versus a fund manager in the driving seat.

“The advantage of owning a leveraged property means you can also increase the total value of that super fund.”

She adds as a trustee, you’re responsible for failure or success of the SMSF’s investment strategy, so it’s important to seek independent and unbiased advice when it comes to what type of property to buy, and where.

Beeton adds most people reading API magazine would obviously be big property lovers and have plans to build a portfolio.

They might consider shares a risky strategy, because they have less experience or knowledge about them.

Offset accounts

Sandkuhler says a couple of lenders have just started to allow the set-up of offset accounts, as part of the SMSF property loan structure.

Not everyone knows about this, but it’s something that could go a long way to helping many property investors.

“You can’t redraw equity out of a primary asset but if there’s an offset account you have the ability to put money into it and withdraw it for future investing within the fund,” she says.

“Only a couple of lenders will do it.” If in doubt, check with a specialist SMSF broker.

Lots of help – FOREVER

While it sounds complicated and somewhat confusing, Brian-Wheatley says a good accountant will be able to guide you through a SMSF.

[sam id=43 codes=’true’]

Even though the structure is complicated, a SMSF can be rewarding.

The ATO is also ‘amazing’ and helpful. “I ring them up, I hound them. They have great and amazing websites,” she says.

And finally, a SMSF will always be there.

Even if you’re 45, chances are you’ll now live until you’re 75, Sandkuhler says.

“You start getting exponential growth after 10, 20, 30 years, so it makes a massive difference to hold the property within the SMSF for a long time.”

……………………………………………………………………………………..

This article first appeared in Australian Property Investor Magazine – Australia’s #1 Magazine for property investors and is republished with their permission.



Want more of this type of information?


Lauren Day

About

Lauren Day is the former deputy editor of Australian Property Investor Magazine and an avid property investor. Visit www.apimagazine.com.au


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