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SMSFs and property investment – the taxing considerations

While you should never invest for anything other than long term financial gain, some people are attracted to the shorter term taxation benefits resulting from property investing (often referred to as negative gearing).

But did you know that similar taxation savings could be achieved when investing in property via a SMSF, as it’s likely you will be able to claim a tax deduction for the contributions you make into the SMSF (to assist with loan repayments subject to the relevant concessional contribution caps)? This assumes you are not already making the maximum superannuation contributions (which is currently $30,000 per year for most people).

In the scenario below, the investor that holds a property in a SMSF contributes $13,750 per year (maybe through salary sacrificing) into his SMSF to assist it meet the interest repayments ($13,750 is the difference between the interest expense and gross rental income – ignoring any other expenses). As you can see, the income tax savings are exactly the same.

  No property Property in personal name Property in SMSF
Salary $100,000 $100,000 $100,000
Rental income $16,000
Interest expense ($29,750)
Super contributions ($13,750*)
Taxable income $100,000 $86,250 $86,250
Tax payable $27,624 $22,057 $22,057
Tax saving Nil $5,567 $5,657

* The SMSF may have to pay for contributions tax (15%). However, we have assumed that the SMSF’s property related deductions (e.g. interest) will offset the contribution income and the fund would report close to nil taxable income and therefore not have to pay any tax.

Some benefits from investing in property with a SMSF

  1. Taxation savings – a 15% maximum income tax rate during the SMSF’s accumulation phase (10% CGT rate on any capital gains) and zero tax on both income and capital in pension phase. Therefore, upon retirement, you could sell an investment property and avoid having to pay any Capital Gains Tax.
  2. Asset protection – superannuation assets are protected from a trustee in bankruptcy. A SMSF is probably the best asset protection vehicle available.
  3. Income tax effective – you can achieve the same or similar income tax savings through making tax-deductible superannuation contributions (called concessional contributions).
  4. Improve cash flow – your compulsory super contributions (i.e. 9% which employer contributes) can be used to fund property holding costs, thereby increasing your borrowing capacity.
  5. Land tax – a super fund is a trust and therefore could attract lower land tax rates in some States or Territories (also depends on existing property a holding).

Some negatives from investing in property with a SMSF

  1. Money is locked away – investing in super means the investments are locked away inside the super fund until you reach retirement age, which for most people is age 65. This may not suit you if you want the flexibility to retire early.
  2. Land tax – a super fund is a trust and therefore could attract higher land tax rates in some States or Territories (also depends on existing property a holding).
  3. Cost – the set up costs and ongoing costs may be higher compared to holding an investment outside super. These costs will be met by your super fund.
  4. Asset allocation – if you purchase a residential investment property within your SMSF, your overall investment allocation may be overweight in direct property (depending on the overall fund’s investment balances). This could also be a benefit depending on the size of your fund.

Warning: risks

There are a number of legal, compliance and financial planning risks associated with SMSF borrowing so it’s very wise to discuss these with your advisors prior to entering into such arrangements. Some commonly identified risks are:

  • Stamp duty or capital gains tax levied on the property when it transfers into the fund (good quality documentation will greatly minimise this risk).
  • If a property is split over two titles (e.g. apartments often have a car park on a separate title), you may need two loans and Bare Trusts – but how to you apportion/split these loans?
  • Liquidity needs to be considered. One of the advantages of super is the nil tax rate when the Fund is converted into pension phase. If your entire super is invested in property, you wouldn’t be able to convert to pension phase.
  • The government could alter contribution limits down, potentially starving the SMSF of the cash flow it needs to meet loan repayments. Be careful not to over-commit the SMSF.

Overall, SMSFs can be incredibly effective vehicles for structuring your property investment portfolio. But as with any other type of investment approach, the pros and cons for your specific circumstances and requirements must be carefully weighed up and discussed with a suitably qualified advisor.

With increasingly close scrutiny and harsh penalties applied to these structures, it is essential that you get the balance right, so as to avoid fines of up to $10,000 and loss of fund assets.

For more information on how you can manage and maximise your property investment debt, click here to contact us, or subscribe to receive regular post updates and industry insights.

Stuart Wemyss is a chartered accountant and founder of Property Tycoon Finance. Email: wealth@propertytycoonfinance.com.au

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