Changes allow Self-Managed Superannuation Funds to Borrow

Director of Financial Dynamics, Frank Taylor, says “The change in regulations is now an important reason to consider a SMSF over a public offer fund.”

Many Self Managed Superannuation Funds (SMSF’s) do not have sufficient money to purchase real estate outright. However, it’s now possible for a SMSF to borrow money to buy rental properties, including residential, commercial and retail, providing a special structure is used and the existing SMSF legislation conditions are met.

The Superannuation Industry Supervision Act (SIS ACT) was amended in September 2007 to permit SMSF's to use borrowing similar to instalment warrants for any asset that a SMSF could otherwise invest in.

Borrowing Rules

The Trustee of a SMSF can borrow in the following circumstances:

• The current SMSF deed does not specifically prohibit such an arrangement (in such case, the Trustees may be required to amend the deed to ensure the fund can access the new concession).
• The borrowing is in the name of the SMSF Trustee.
• The borrowing is to acquire an asset that the SMSF Trustee is allowed to acquire. For example, a SMSF can not acquire residential property from a member or their business, but their business premises would be suitable as would residential property from a non-related party.
• The asset must be held by a separate Trustee (“the holding Trustee”) under an arrangement where the Trustee of the SMSF makes an instalment payment into the trust to obtain beneficial ownership with further payments required to obtain full legal ownership. Any income such as dividends, rents or interest accrues for the benefit of the SMSF Trustee.
• The borrowing is non-recourse (the superannuation law may be breached if Trustees give personal guarantees)  and at the end of the loan period, provided all payments have been made to the lender, the holding Trustee will transfer full legal ownership of the asset to the Trustee of the SMSF.  

The following example shows how a SMSF using the new concession can save you thousands: 

• Bill is a 56 yr old employee earning $80,000pa.
• He has $200,000 in his SMSF and is considering purchasing a rental property.
• He needs $300,000 to purchase a $500,000 property.
• He estimates the rental property will generate $20,000 income pa and have a capital growth 7% pa.
• A Financier will provide finance for $300,000, however 11% interest will be charged due to the additional risk associated with the limited recourse nature of the loan.
• Ordinarily, 9% interest would have been charged had the loan been secured by other assets (ie a ‘standard’ mortgage arrangement).
• Property costs (other than interest - ie agent fees, council rates etc) are estimated at $6,000.
• It is anticipated that Bill will sell the property in 5 years when he is over 60 and fund in pension mode.

After-tax position by purchasing property in taxpayer’s name

Rental income                                                                $20,000

Less: Interest based on borrowing

$450,000 @ 9% ($50,000 deposit)            $40,500

Other expenses                                       $ 6,000            $46,500

Annual rental property loss                                             ($26,500)

Less: Tax benefit in fund 31.5%                                         $ 8,348

Annual after-tax cost in fund                                           ($18,152)

Total cost over 5 years                                                   ($90,760)

Plus capital gain after 5 years @ 7%                              $201,276

Less: Capital gains tax payable @ 41.5%

(applying 50% discount)                                                 ($41,765)

Overall after-tax position                                                   $68,751

After- tax position by purchasing property in SMSF

Rental income                                                                 $20,000

Less: Interest based on borrowing

$300,000 @ 11%                                     $33,000

Other expenses                                        $ 6,000            $39,000

Annual rental property loss                                             ($19,000)

Less: Tax benefit in fund @ 15%                                       $ 2,850

Annual after-tax cost in fund                                             $16,150

Total cost over 5 years                                                    ($80,750)

Plus tax-free capital gain after 5 yrs @ 7%                       $201,276

Overall increase in after-tax position                                 $120,526

Increase in overall after-tax position by

purchasing property in the SMSF                                  $51,775

NOTE:

One of the main reasons for borrowing in your SMSF would be to utilise the assets you already have in your fund, therefore reducing the amount you need to borrow.

Even though the above example is based on the comparison of an individual borrowing $450,000 and a SMSF borrowing the lesser amount of $300,000, the overall costs charged to the individual over 5 years (after being reduced by the tax benefit) is only $10,010 greater ($90,760 - $80,750) than the lower costs associated with borrowing only $300,000 in the SMSF.

However, the major reason you would undertake this investment within your SMSF is not so much the interest saving, but the big tax saving when you sell the property after you turn 60 due to the tax-free capital gain.

Additional gains could be made by making contributions to counteract the losses in the SMSF and making even greater tax savings!

For further information regarding SMSF's, please contact one of our highly skilled Client Managers at Financial Dynamics on 442 12345.  

Tel: 02 4421 2345Fax: 02 4421 2340