For those who love property, there’s another reason to get excited. Borrowing to acquire property with self-managed superannuation entitlements has been possible but restrictive.
However, recently this financial strategy been supported with revised legislation that will now enable super investors to plan for the future with greater certainty and confidence.
We borrow to buy our home, we finance car purchases with lease arrangements, we borrow to invest in shares and property, and we can now also borrow to acquire residential, commercial or industrial property within our self-managed super funds.
Why would you borrow to invest in property with super? There are clear tax benefits to be gained by choosing to invest in property with self-managed superannuation capital. It must be said that these benefits can also apply to other superannuation investments and are not specific to property, thereby highlighting the tax benefits associated with superannuation.
These can be summarised as:
1) Capital gains tax.
2) Rental income tax.
3) Salary sacrifice tax
4) Superannuation pension tax
Undoubtedly the greatest tax benefit associated with investing in property within a Self-Managed Superannuation Fund (SMSF) is the potential capital gains tax concession on capital growth. If the property is sold while in accumulation phase after being held for more than 12 months, a 10 per cent tax rate applies. However, if that same property is sold after the super fund has converted to pension phase (that is in retirement), zero per cent tax applies. Therefore, the longer you hold the property, the greater the likely capital gain and the larger the tax benefit.
Rental income is also concessionally taxed for properties owned by your super fund. As with capital gains tax, in the pension phase no tax will apply to rental investment income, and a flat 15 per cent will apply in accumulation phase. This is also extremely favourable when comparing neutrally or positively geared property with rental income taxed up to 46.5 per cent for property held in an individual’s name.
The Australian Tax Office allows individuals to make pre-tax salary-sacrifice contributions into super, paying 15 per cent contributions tax in super and saving marginal tax in their own name, which again could be up to 46.5 per cent. More after-tax dollars to invest allows greater wealth to be accumulated and/or more debt to be repaid.
It is commonly known that at 55, workers (employees or the self-employed) can establish a “transition-to-retirement, account-based pension”. This financial strategy was legislated with the intention of allowing workers to phase into retirement by supplementing part-time hours and remuneration with an additional income stream. The reality is that it is being taken advantage of by many full-time income earners.
Superannuation pension payments can be received while working full-time or part-time. The benefits are twofold. First, in pension phase, as stated above, investments will be capital gains and rental income tax free. Secondly, pension payments made from super to an individual are also concessionally taxed and will actually be tax free from age 60. Therefore, the typical transition-to-retirement financial strategy involves swapping higher taxed salary income with lower taxed pension income, thereby allowing additional salary-sacrificed super contributions to be made.
The only opportunity cost associated with personal investment property ownership is the personal tax benefits associated with negative gearing on marginal tax rates of up to 46.5 per cent. While this may be the case, there wouldn’t be too many property ownership scenarios where these negative-gearing tax benefits outweigh the tax benefits associated with gearing and owning property within superannuation.
In addition to taxation benefits, there are two core reasons why you would consider gearing in superannuation. First, the strategy can bring forward property ownership in super. For example, instead of acquiring a $500,000 property at, say, age 60, the same property could be acquired with $250,000 superannuation capital and $250,000 debt at age 50.
Secondly, for the same reasons that we borrow to invest in property in our own name for investment, when we are confident the return (income and growth) will exceed the cost of borrowing, you come out ahead financially by “gearing or leveraging” into property.
To simplify the maths, in the current interest rate environment, borrowing at rates of 7 per cent and renting at a yield of 3 per cent, capital appreciation of more than 4 per cent a year will result in a positive financial result.
So, how can this investment opportunity be exploited? While the rules and regulations of borrowing to acquire property in super have been revised, they are still complex and the costs of incorrect structuring and management can be harsh.
Here are some facts associated with taking advantage of the superannuation borrowing rules, known as “limited recourse borrowing arrangements”.
l The super fund needs to establish a new trust. The name of this trust typically is known as a bare trust, custodian trust or security trust.
l It is required that the trust has a new corporate trustee, rather than individual trustees. While the super fund may already have a company in place acting as trustee, a new and independent company is needed specifically for the trust.
l The new trust is established to act as the legal title holder of the property that is acquired, and the super fund has a beneficial interest in the asset until the debt is repaid, at which time the property is transferred into the name of the super fund.
l The loan can be used to acquire a “single acquirable asset”. As a result, if multiple properties are acquired, multiple trusts and corporate trustees are required, as each trust can only own one property.
l While a separate trust owns the property, the super fund is deemed to own the property for tax purposes.
In order to avoid potential financial consequences of double stamp duties and non-compliance of the super fund, it is advised that superannuation structural planning is conducted and that specialist financial guidance is sought before property contracts are entered into and signed.
Michael Rafferty, from Super Fusion, is one of few specialists in this space of project managing the various service providers to ensure that the “loan arrangement and property purchase” is compliant and efficient. Michael liaises with accountants, finance brokers, lawyers and financial planners for the benefit of his clients, and says that “planning for the acquisition is essential”.
Despite the additional work and planning requirements involved in taking advantage of
limited recourse borrowing arrangements within SMSFs, the tax benefits associated with the strategy of potentially ending up with an income tax and capital gains tax-free property in retirement can make it all worthwhile.
Adam Watts
LifeTime Financial Group
adam@yourlifetime.com.au
If interested in learning more about this update please contact me today!
Tags: accumulation phase, capital, capital gains tax, cent, property, salary sacrifice, self managed superannuation fund, strategy, Tax, tax concession
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