Strategy: Buying Property Inside an SMSF
Setting up an SMSF gives you the power to choose where to invest your fund, including residential or commercial properties.
Residential vs Commercial Property
+ Residential Property
Buying a residential property through an SMSF has the following restrictions:
- a trustee or anyone related to them cannot sell their property to the SMSF;
- the purpose of the purchase should ONLY be used to provide retirement benefits to the members of the SMSF; and
- the residential property can neither be occupied nor rented by a trustee or anyone related to the trustee.
The restrictions above are reminders of why you may not be able to buy your vacation house or primary house using SMSF just to get away with paying more taxes!
However, if you are an individual with a high marginal tax rate and the purpose of the residential property is for leasing, then using an SMSF might be a good choice! This is because the tax rate on rental income is fixed at 15%. It is also good to note that when you sell residential property owned for more than a year, your capital gains tax is taxed at a lower rate of 10%.
The difference between acquiring a commercial property and a residential property is that commercial properties can be leased and acquired by the members of the SMSF.
+ Commercial Property
How will you know if the strategy of buying a commercial property is right for you?
It is a recommended strategy for business owners and medical practitioners who have their own clinic, as these groups can get the most benefit out of it.
Here are some advantages to having a commercial property as an investment in your SMSF:
secured tenancy of your business in your property;
the property is protected as it is under the SMSF, which is a separate entity from your business; and
the rent you pay to the SMSF becomes a tax deduction for your business and an income for your SMSF, which increases your fund.
Case Study
An SMSF is a particularly powerful structure for small business owners that run profitable businesses.
The case study below illustrates how an SMSF can be utilised for wealth creation and retirement planning.
Take for example Mr. Smith.
Mr. Smith is a director of his private company that runs a business.
The business hires himself and his son as employees within the business.
Mr. Smith is 61 years old. He has $250k in his retail superfund.
Mr. Smith decides to retire from his position of Director and instead his daughter takes over the role of Director. Mr Smith continues to be employed by the business in his capacity as an employee.
Mr Smith makes a request with his retail superfund to withdraw 100% of this member balance as a lump sum withdrawal based on satisfying the ‘retirement’ condition of release given that he has retired from his role as a company director.
Mr Smith set ups a self-managed superannuation fund and contributes the lump sum as a non-concessional contribution into the SMSF effectively converting the taxable component of his member balance to 100% tax free component.
His son and daughter also become members of the SMSF and rollover their member balances.
The SMSF purchases a commercial property using the funds available inside the self-managed super fund.
The business pays rent to the superfund for the use of the commercial property.
The superfund is currently in accumulation phase, meaning it pays 15% tax on all income including all employer contributions and rent paid from the business.
Once Mr Smith reaches 65 years of age, he will satisfy the ‘age’ condition of release enabling him to commence an accounts based pension from his self-managed super fund.
The commercial property can be segregated so that the property is the only asset that supports Mr. Smiths’ pension given that his member balance is the majority of the fund compared to his son and daughter.
This means that the earnings on this asset, being the rent paid from the business will be entirely tax free inside the superfund enabling Mr. Smith to withdraw 100% of the rent as his pension.
The company would be entitled to a tax deduction at 25% for the rent paid as it is a valid business expense and the superfund pays 0% tax on the rent as the asset is segregated and support Mr. Smiths’ account based pension.
Mr. Smith will need to satisfy the minimum pension withdrawal every year which is currently at 5% of his member balance for the ages between 65 and 74.
Key takeaways from this case study
It is best to engage your adviser to help you work through the multiple steps in the strategy illustrated in this case study. It is important to understand your borrowing capacity if you need to borrow inside super and make sure you understand the rules around buying property inside your SMSF.
At Star Advisers, we are licensed financial advisers that specialise in SMSF advise. We can help you set up an SMSF. Contact us to book an initial consultation.