Most Australians are obsessed with property.
When self-managed super funds were permitted to borrow in 2007, the majority of Australians were excited to jump at the chance of acquiring an investment property using their super.
However the super law is quite strict in its requirements when a SMSF enters into a borrowing arrangement to acquire a property. In order to purchase a property using a borrowing inside an SMSF, trustees must comply with a specific set of rules. Essentially, the rules require the establishment of two trusts in one.
The first trust is the self-managed super fund whereby trustees make their own contributions and rollovers. The second trust is the bare trust, which is set up to hold title to the property asset, until the SMSF borrowing is repaid to the lender.
SMSF borrowings can take place under any commercial arrangement, whether the borrowing is from a bank or another related party. As long as the arrangement is an arm’s length transaction, a loan agreement is in place, interest is being charged at commercial rates, and repayments are being made, the loan will comply with the super law.
First things first. For an SMSF to legally purchase a property, the property in question must meet the following criteria:
- The ‘sole purpose test’- which basically requires that the property is held solely with a view to providing retirement benefits to the members of the fund.
- Must not be acquired from a related party of a member, unless the property acquired is business real property (i.e. used for one or more business purposes)
- Must not be lived in by a fund member, or any fund members’ related parties, until they meet a condition of release.
- Must not be rented by a fund member or any relatives of the members.
The structure that must be put in place for your SMSF loan arrangement is called a limited recourse borrowing arrangement.
Some organisations refer to this as a bare trust arrangement or custodian trust. All of these terms refer to a structure whereby a separate trust is established to hold the title to the asset being purchased, until the loan is repaid.
In essence, what the law does is protect the SMSF’s other assets from being seized by the lender in the event of a default. The bank’s only recourse is to take possession of the property being used as security. Fund assets, such as shares, units in unit trusts, bank accounts and other property without borrowings attached, are kept safe from the hands of the bank in the event of a default.
The reason why the trust is often referred to as a bare trust is that it is effectively bare. It does not have a requirement to obtain an ABN or tax file number. There is no requirement to prepare financial statements or lodge a tax return. Its only purpose is to act as the custodian of the property title.
To maximise the bank’s lending ability, the SMSF is usually established with a corporate trustee. The bare trust is also established with a corporate trustee.
On top of the fees that you will need to pay to establish your SMSF, there are many fees associated with purchasing a property inside your fund.
These fees are all payable by your super fund. They effectively reduce your member balance. Before you go ahead with your SMSF borrowing, we suggest that you do your research by contacting us so that we can guide you through the process.
The typical fees associated with a purchase include:
- Upfront fees – set up costs relating to the borrowing structure.
- Legal fees – including solicitor’s advice fees relating to guarantees.
- Advice fees – from a financial planner who is required to give you a statement of advice (SOA) prior to proceeding with the purchase.
- Stamp duty – typical investment duty fees apply.
- Ongoing property management fees.
- Ongoing expenses relating to running a property – similar to those you would pay to run a property outside an SMSF.
- Bank fees including loan establishment, mortgage registration fees, trust deed review fees and any other fees that the bank will charge you.
In all cases, due to the complexity of these arrangements, and the costs involved, we always recommend that you obtain a pre-assessment or pre-approval via a bank or a mortgage broker prior to establishing the above structure.
It is always best to be assured that you have the ability to borrow inside your SMSF, and to find out exactly how much you can borrow – prior to committing to an SMSF. This is not a decision to be taken lightly. Careful consideration and research is required to ensure the longevity of your SMSF to ensure that it complies with the superannuation legislation.
Once you have settled on your SMSF, you will have ongoing obligations relating to running the investment property and the SMSF. The following ongoing responsibilities will apply:
- You will need to engage an accountant to prepare the financial statements, member statements and annual tax return for the fund.
- You will need to arrange for a separate independent auditor to conduct an annual audit of the fund. The accountant you engage will ordinarily look after this on your behalf.
- You will need to look after the running of the investment property which including:
- engaging a real estate agent to look after the property management.
- arranging for the appropriate insurance cover for the investment.
- paying ongoing expenses such as rates, water and sewage charges, repairs, maintenance and insurance costs.
No matter how many consultants you engage, and what level of service you pay, the ultimate responsibility for carrying out these tasks and running your SMSF rests with you as the fund trustee.