The ATO has released their bulletin for SMSFs highlighting their concerns with some of the riskier approaches to property investments. There are numerous strategies and ways for property to form part of an SMSF’s investments and each must be carefully considered to ensure it is within the law as well as meeting the SMSF’s investment strategy.
A common form of property investment is direct investment into a property. This can be in the form of either a residential property or commercial property. When purchasing a property with an SMSF’s cash there are some important considerations that must be worked through including:
- Asset allocation and diversification.
- Potential rental income and property expenses.
- How close the members are to retirement and the need for liquid assets to pay pensions.
- Unless the property is a business real property (BRP) trustees or their related parties cannot use the property:
- If the property is BRP the trustees may be able to work from the premises which is owned by their SMSF, provided an arm’s length lease agreement is in place.
- They may also be able to utilise the small business CGT concessions and contribution limits.
Limited Recourse Borrowing Arrangements (LRBA)
SMSFs may also invest in property through an LRBA. These are complex borrowing structures which allows SMSF trustees to take out a loan from a third party lender. The SMSF trustee then uses these funds to purchase a property to be held on trust. The lender only has recourse to the property held in the trust – this is why the loan is “limited recourse”.
An LRBA should only be utilised when it is the right structure. Some very important considerations in addition to the ones above include:
- Can the SMSF maintain the loan repayments over a long period of time considering asset returns, interest rates, liquidity, and contributions caps?
- Evaluating set-up costs and structures.
- Is the property valuation accurate?
- The trustees cannot use borrowed money to improve the asset or change the nature of the property at any time.
- Does the Fund meet the strict lending requirements?
- Typically, lenders require the SMSF to have a minimum of net assets of $200,000 or more and for the loan to have a loan to value ratio (LVR) below 70%.
Another way to gain exposure to property for SMSFs is through indirect investment. This can include listed invested vehicles such as, listed investment companies and exchange traded funds (ETFs). Managed investment trusts are also a common investment for SMSFs to gain exposure to property. Investing indirectly is relatively simple and most likely will not require a large amount of capital. It also allows SMSFs to get exposure to large value properties such as office blocks, shopping centres and industrial properties that would otherwise be out of reach.
While arguably the easiest option for Trustees, indirect property investments is where many of the risks the ATO are concerned about originate. Investing through private joint ventures, partnerships and private unit trusts are all legitimate options, however these need to be structured correctly to ensure ongoing compliance and have a suitable plan in place for if one investment party wishes to sell their portion of ownership.
As with most investments, the best course of action is for the trustees to discuss any potential SMSF property investment with an SMSF specialist first. Not only will the trustees be more informed about their option – it could prevent compliance issues later on!
How can we help?
If you need assistance with any aspect of your SMFS property needs, please feel free to give us a call on 1300 394 544 to arrange a time to meet so that we can discuss your particular requirements and circumstances in more detail.