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Buying a property with an SMSF home loan

Self Managed Super Funds (SMSF) can be quite complex when taking out a home loan for a property – the property must work to the benefit of the SMSF and provide a return so that it will be used to benefit all fund members, usually after the age of 55 for some retirees. Whilst an SMSF home loan allows you to borrow money for the purpose of purchasing a property, there are rules, regulations and conditions that you must follow to ensure that the purchase is legal.

What is a SMSF?

An SMSF home loan is a mortgage controlled by members of a super fund, which is used to buy investment property. All rental income or capital gains are funnelled back into the super fun and cannot be given as a pre-retirement benefit to a member or be disposed of by a trustee.

Instead, it can be used to increase retirement savings that will be paid out upon retirement. Furthermore, regulations exist so that the property can only be used for investment purposes that benefit the superfund. This means members and their family cannot reside in the property acquired by SMSF.

As a member of an SMSF, you have the ability to nominate properties and choose what to invest in and all running expenses are paid by the fund. However, investments made under an SMSF home loan have to be made in the best interests of all fund members and in accordance with the legal conditions around SMSF borrowing.

How does an SMSF home loan work?

Because all SMSF properties work in a way to benefit members upon retirement, the SMSF chooses each property they wish to invest in. Residential property is purchased from an agent or vendor (without influencing one another), and non-residential property can also be purchased from related parties as long as the property for business purposes only. Like any other property, the SMSFs nominated conveyancer will deal with any requirements prior to settlement, and the SMSF will pay the deposit, remaining balance on the property, legal costs and stamp duty. The SMSF is also responsible to pay the costs that are expected from a usual investment property, including council rates, water rates, property management costs and insurance premiums.

Each SMSF will have a bare trustee who is nominated by the beneficiaries. The bare trustee must be a separate corporate entity from the SMSF trustee. Bare trustees play no active duties other than releasing the property to SMSF members once the home loan has been completely paid off. When making a property purchase however, it must be in the name of the bare trustee, and on completion, the bare trustee mortgages the property to the lender.

When is an SMSF allowed to borrow money?

These are the rules a trust must follow in order to borrow money:

  • The asset is an asset the SMSF could otherwise legally acquire (if it had the funds).

  • The asset is held on trust for the SMSF using a security trust (known as a security custodian).

  • The SMSF acquires a beneficial interest in the asset from the outset.

  • The SMSF has the right to acquire legal title from the security trustee upon making all loan repayments.

  • The lender must only have limited recourse against one particular asset. This means that in the event of a loan default, the lender must not be able to claim any other assets of the fund.

  • Each borrowing arrangement can only be for a “single acquirable asset”. In the case of strata title or subdivisions, each title is considered a separate asset.

Benefits of a SMSF

  1. Range of investment choices - As a member of a SMSF, trustees are able to access a range of investment options such as direct shares, term deposits, income investments, unlisted assets and cash accounts.

  2. Investment flexibility - SMSF assets are in the control of the trustees, meaning they are responsible for all decisions relating to investment in properties. There is also greater flexibility on when to acquire and sell properties, which can be advantageous if market conditions suddenly change.

  3. Low tax - Tax on investment income for SMSFs are capped at 15% in Australia, one of the lowest tax rates on entities. In the pension phase of properties, there is no tax payable (including capital gains tax). This tax rate can be reduced even further by offsetting other tax credits. Strategically managing SMSF properties can help grow super savings and reduce tax payments.

  4. Ability to pool your super - Most SMSFs allows members to pool their resources with up to three other fund members, such as family members or partners. The additional resources may allow for greater investment opportunities that may not be available otherwise.

  5. Investment transparency - Trustees can use SMSFs to align their personal goals with investment decisions, whether it be about property, shares, ethical investing or sustainable practices. SMSFs provide members with a platform that allows members to understand where money is being invested, with complete transparency over performance.

Disadvantages of a SMSF:

  • Penalties for breaches and non-compliance - For members that breach the regulations of a SMSF, the tax office holds the power to remove any fund’s complying status. The market value of a non-complying fund is then taxed at the highest marginal rate, which could heavily affect the retirement savings of all fund members. Trustees can also face civil and criminal charges if the breaches are serious.

  • Big responsibilities - All decisions made within the SMSF rests with the members. This means trustees are responsible for the operation of the fund, its investment performance, any taxes and the governing rules of the fund. Members are also responsible for making sure the fund meets all requirements, regulations and conditions on time, so keeping up with deadlines is crucial or penalties will occur.

  • No Access to Complaints Tribunal and lack of Compensation Scheme - Members of SMSFs are not able to bring their complaints to the Superannuation Complaints Tribunal. Instead, they will need to go through the court, which may become expensive and become delayed. Compensation arrangements are also inaccessible for trustees as members are responsible for all operations of the SMSF, including investment decisions on properties. This can severely limit the avenues of compensation available to members.

What are the features of a SMSF?

When you set up an SMSF, you must manage it according to the rules set out in your trust deed. Since the purpose of an SMSF is to provide retirement benefits to members, the rules of the fund must reflect this.

The following is a list of important facets of an SMSF:

  • Manage the fund’s investments: all investments should be managed for the benefit of the fund members and personal financial affairs or interests should not be incorporated in any way. These must be kept separate. The ATO has strict rules concerning asset ownership with all assets required to be held in the full legal name of the SMSF.

  • Contributions from fund members: these can be accepted, but there are some restrictions in place, depending on the age of the member and their contribution caps. These caps change every year and there are penalties for over-contributing, so it is best to carefully plan any extra contributions.

  • Administration: If you are the trustee of the super fund, you will have to ensure that you meet all reporting requirements and maintain records of the fund’s undertakings. An accountant can assist you with the annual income tax, reports and audit.

  • Access to the fund: members will be eligible to receive super funds once they reach the ‘preservation age’, retire or meet any other conditions of release. Generally, it is very hard to touch your super before reaching the required age unless you are experiencing severe financial hardship.

  • Tax: super income is generally taxed at a rate of 15%. However higher rates may apply if you receive “special income” from investments in entities related to you or if you receive a notice of non-compliance for breaching the super fund rules.

Rules relating to Self-Managed Super Funds

There are special rules governing how super funds must be run:

  • The fund must always be run with the sole purpose of providing retirement benefits.

  • You cannot use an SMSF to gain early and improper access to superannuation.

  • SMSFs can now borrow as long as certain requirements have been met.

  • The SMSF trustee can either be a company owned by all members or all members as individual trustees.

  • An SMSF can have between one to four members.

  • The SMSF must always maintain and follow its investment strategy.

  • The trustee must ensure that the SMSF complies with the Australian Taxation Office (ATO) regulations and guidelines.

Who is eligible for a SMSF home loan?

The conditions in which a trust must satisfy in order to borrow money for a SMSF home loan includes:

  • The asset is one in which the SMSF could otherwise legally acquire (if it had the funds)

  • The asset is held on trust for the SMSF using a security trust

  • The SMSF acquires beneficial interest in the asset from the outset

  • The lender must only have limited recourse against one asset. In the event of a loan default, the lender can not claim any other assets of the fund

  • Each borrowing arrangement is done only for a single asset. In the case of strata title or a subdivision of property, each title is considered its own asset.

Lenders also look for particular requirements when lending to an SMSF:

  • The deposit is expected to be at least 30% of the property value

  • Rental income from the property is factored into the borrower’s ability to make repayments

  • How frequently members make contributions to the fund, as this amount will be relied on to meet repayments of the loan

  • Structure of SMSF must be compliant with ATO and ASIC rules.

Tips for managing an SMSF

Here are a few things to remember when starting an SMSF:

  • Make sure that you fulfil all your administrative obligations, including record keeping and taxation.

  • Enlist the services of an auditor as required by the ATO.

  • Prepare all financial statements and maintain good records.

  • Know the law so that you can comply with the ATO and government regulations.

  • Never enter into any commercial or financial arrangements that involve your SMSF without first seeking professional advice.

  • Do not access your SMSF unless you have met all conditions. It is illegal to prematurely access your super fund and there can be heavy penalties for the fund member and the fund.

Why use a mortgage broker?

For a standard home loan there is only a small difference between different lenders. However, for an SMSF loan there are big differences in fees and interest rates.

In particular, many major banks process loans for SMSFs via their commercial or business banking department. These parts of the banks have much higher costs than the normal home loan department, and as a result they charge more for their loans.

The residential investment and commercial loans offered by the major banks are not as competitive as those offered by smaller banks and building societies. Many lenders pulled out SMSF lending in 2018.

Speak to a professional finance advisor

To ensure that you are complying with all of the regulations, speak to a tax agent who can offer you specialist taxation and financial advice. Make sure you read all information available and access the relevant resources so that you are fully informed. You are responsible for your SMSF so it is important that you adhere to the ATO rules.

Getting the right advice means that you will have the appropriate structure for your SMSF trust loan, minimising any legal issues.

Need more information?

If you need further information, get in touch today to discuss your ability to avoid LMI and how we can help you obtain a competitive home loan.