Costly pitfalls can await, especially when borrowing is involved.
Property spruikers can be persuasive at the best of times, but it appears there could be a whole new breed circling potential investors.
The growing number of self-managed superannuation funds (SMSFs) are proving a powerful lure for developers and sales people since the Australian Taxation Office (ATO) provided clarifications on the rules for SMSFs borrowing to invest in residential property.
It is no secret many Australian investors favour the tangible nature of bricks and mortar over the volatility of equities. The case for property may have been heightened following the global financial crisis, along with the increasingly popular belief among individuals that they can run their own retirement fund as well as many specialist professionals.
While the strategy of setting up a SMSF and then using the money in it to buy property will work for some, it isn’t for everyone and it comes with considerable traps, warns Andrew Albury, a director of financial advisory firm MGD Wealth. The compliance issues associated with running a SMSF can be considerable at the best of times, but there is an added layer when borrowing and property investments are involved, Albury says.
Furthermore, borrowing money to buy property isn’t the only way to invest in property via a SMSF.
“The relatively new borrowing rules are quite prescriptive in nature,” he says. “That means it is also easy to structure transactions incorrectly and this is why it is crucial SMSF trustees looking at investing in property this way get specialised advice to get it right.”
It is not unusual for Albury and his financial adviser colleagues to meet investors who have signed a property sales contract and paid a deposit without first establishing an SMSF or, worse still, the necessary borrowing trust.
Not surprisingly, the consequences of this and the additional costs incurred to fix it can be considerable.
A major part of the problem often stems from the persuasive nature of property sales people, many of whom are unaware of the regulations governing SMSF investment, let alone the broader financial circumstances and objectives of the individual and whether or not the investment decision makes sense, Albury says.
SMSF transactions must be structured correctly and in the best interests of the trustees, he emphasises.
SMSFs are a financial product in their own right and anyone advising on them ideally needs to hold the relevant financial services licence.
In the nine years to 30 June 2012 the ATO has reported a 43 per cent increase in the number of SMSFs, to 478,263, along with an expanded compliance program.
According to the ATO, some of the general compliance issues around SMSFs borrowing to buy property include:
- Lack of proper and correct documentation, with loan contracts signed between financial institution and the bare trust rather than the SMSF.
- Confusion between the members and trustees of SMSFs ultimately resulting in breaches of the limited recourse borrowing arrangements.
Aside from falling foul of the ATO, other issues arising from SMSF trustees dealing with non-licensed specialists are:
- Rolling over super from a retail or other fund into an SMSF and forgoing any attached life insurance.
- Buying a property without any prudent analysis of whether it is a good investment decision or consistent with defined retirement goals and objectives.
- Paying too much for property and the associated costs involved in the limited recourse borrowing arrangements.
- Struggling to meet the finance requirements going forward if the property is untenanted for a long period or member contributions cease to be paid into the SMSF for some reason.
For many SMSFs borrowing to buy a property will fit the overall purpose of superannuation: to benefit the member or members in retirement. If that is the case, there are several steps for trustees to take in order to ensure compliance.
This article is from the March 2013 issue of INTHEBLACK magazine.
- The SMSF’s trust deed must have the power to borrow and the fund’s investment strategy must allow the purchase of property.
- Once the property is bought – hopefully after doing all the right research – it must be held in a separate entity, known as a bare trust, until the associated property debt is paid off.
- Loans from financial institutions must be non‑recourse, so if something goes wrong the lender can only lay claim to the property and has no recourse to the other assets of the fund. The loans must also be principal and interest.
- Careful planning is needed to get the loan correctly settled to guarantee compliance with Australian superannuation legislation and for stamp duty reasons, says Michael Hallinan, special counsel for Townsends Business & Corporate Lawyers.
- The holding trust deed must be stamped to ensure any ultimate transfer from the holding trustee to the SMSF trustee attracts only nominal stamp duty, says Hallinan. It must also be stamped within the period allowed for stamping. The holding or bare trust deed cannot be stamped until after settlement, Hallinan says, and the duties authorities need confirmation that the settlement money came only from the fund (and its lender).