Buying property with an SMSF loan

What is an SMSF?

Unlike retail and industry super funds that most of us contribute to, with a self-managed super fund (SMSF) you choose and manage the investments yourself, and have complete control of how your money is invested.

This means you can invest directly in a wide range of investment types to achieve your retirement objectives, including property - as well as others like shares, fixed term deposits or commodities. The other difference between an SMSF and other types of funds is that the members of an SMSF are usually also the trustees. 

It’s an attractive concept but your first step should be deciding if it is the right choice for you. Besides making all the investment decisions for the fund you are also responsible for complying with the relevant superannuation and tax laws. You also need the time and financial know-how to set up the fund and manage it, though many people get help.

We strongly suggest you should seek the appropriate professional advice as the rules and obligations around SMSF can be complex. 

Is it worth setting up an SMSF?

If you are looking at setting up an SMSF you need to work out if it is cost effective, which ultimately depends on your personal financial circumstances.

Taking into account establishment and on-going costs, industry experts generally acknowledge you need anywhere from $120,000 to $200,000 to make it worthwhile. In terms of overall costs you can expect these to be in the region of:

• $2,000 and $5,000 for set up
• $3,000 annually for compliance 
• $500 and $1,500 for an annual audit

Assuming this is within your means let’s move onto an overview of how you set up an SMSF,  a step most people engage the appropriate professional. 

How to set up an SMSF in 5 steps

If you decide an SMSF is right for you will need to take the following steps to get it set up: 

1. Create a trust - A trust is a legal tax structure that can consist of individual trustees or a corporate trustee (essentially, a company acting as trustee for your fund). Trustees are responsible for managing the SMSF’s assets and ensuring it is compliant with Australian Tax Office (ATO) and Australian Securities and Investments Commission (ASIC) rules - the two entities that regulate SMSFs in Australia.
2. Create a trust deed - This sets out all the rules and conditions which govern how your SMSF will operate. This is typically a document a legal practitioner will help you draft, to ensure trustees maximum control and flexibility.
3. Sign a declaration form - This confirms you understand your obligations, duties and responsibilities as a trustee or director of the SMSF. These include, but are not limited to acting honestly, and in the best interest of all members.
4. Register your SMSF with the ATO - Within 60 days register your SMSF with the ATO by applying for an Australian business number (ABN).
5. Open a cash account - The trustee of an SMSF will need to set up a bank account that is unique to it, and separate from all member’s accounts. This is so the fund can accept contributions, earnings from investments and to pay expenses from. Once set up you need to notify the ATO of the details of the account. 

Tip: This is a simplified summary, if you are considering setting up an SMSF, or purchasing a property in your fund you should seek the appropriate professional advice, as the rules around compliance can be complex. The ATO also has excellent resources covering setting up an SMSF correctly, so that it's eligible for tax concessions, can receive contributions and complies with the relevant super and tax laws. 

Now you have a better idea of what is required to set up an SMSF let’s look at the benefits you can expect.

What are the benefits of an SMSF?

Besides giving you direct control of your investments, there are many benefits of an SMSF, including:

• Giving you a wide range of investment options, including residential and commercial property. 
• Making changes to your portfolio, allowing you to react to prevailing market conditions.
• Reducing your tax liability by buying a property through your self-managed super fund (SMSF). 
• Providing income for your retirement, once the property is paid off and owned by your SMSF.
• Funding the purchase of further investments, using the cash flow from the rental income.
• Allowing you to pay off the SMSF loan quickly, using the rental income the property generates. 
• Avoid paying percentage fees based on your super balance, which is how super funds typically charge members.

Let’s take a closer look at the tax benefits of an SMSF, presuming you have invested in property, as this could help you maximise the returns for your fund. 

The tax benefits of an SMSF

An SMSF can help reduce how much tax you pay, including limiting or avoiding capital gains tax (CGT), depending on how long your fund has held an investment property. Key benefits to be aware of include:

• Tax on SMSF earnings is capped at the same rate as other types of super fund (15%). This means the maximum tax payable on the property’s income is 15%. Any expenses such as interest, council rates, insurance and maintenance can be claimed as tax deductions by the SMSF.

• Capital gains tax (CGT) is also capped at 10% if a fund holds the property for more than 12 months - and potentially no CGT bill will apply at all if the property is sold after you retire and your SMSF is in a ‘pension phase’.

• An SMSF is permitted to borrow - by taking out an SMSF loan - to purchase assets such as property. Negative gearing can also be used so interest and other costs related to holding the property can be offset against other taxable earnings and potentially reduce tax payable by your fund to zero.

Typical claimable expenses for an SMSF include:

• The interest on your SMSF loan as a deduction
• Management and administration fees paid to investment advisers
• Bank fees
• Expenses associated with a rental property 
• Brokerage fees
• ASIC’s annual fee

Example: If you sell your property while you are still contributing to your SMSF CGT is charged at 15%, but this reduces to 10% if you hold it for more than a year. If you sell the property when you're drawing your pension then you pay no CGT at all.

Now, let’s look at the SMSF loan itself and what makes it distinct from an investment loan.

What is an SMSF loan, and how is it different from an investment loan?

A SMSF loan is a home loan used by a self-managed super fund (SMSF) to buy residential or commercial investment property. 

The returns of the investment (rental income or capital gains on the value of the property) are then retained within the super fund to boost your retirement savings. An SMSF loan works in a similar way to an investment loan but there are some key differences you should be aware of, including that:

• Loans must be supported by personal guarantee(s) required from all members/beneficiaries of the SMSF.
• The security property should be an established residential house, townhouse or a unit.
• You cannot purchase vacant land or undertake construction in your SMSF.
• Equity cash out or redraw are not available with an SMSF loan.

On a technical note you should also be aware that ATO rules state that SMSF can only purchase an asset - like an investment property - using a 'limited recourse borrowing arrangement' (LRBA). An SMSF loan is a LRBA, which is there to protect other assets held by the fund. It means if you default on your SMSF loan, your lender cannot seize any of your other SMSF assets - only the asset that is the object of the loan.

Like most financial products, there are rules around buying property in an SMSF. 

What rules apply to buying property in SMSF?

The ATO has specific rules that apply to property investment in an SMSF, and you need to comply with these, including that the property: 

• Is solely for providing retirement benefits to SMSF members, otherwise known as the ‘sole purpose test’.
• Cannot be purchased from a related party of an SMSF member.
• Cannot be lived in by you or other SMSF members or their related parties.
• Cannot be rented by an SMSF member or anyone related to them.

If it is a commercial premises, the property can be leased to an SMSF member but they must pay market rates. 

Now let’s look at the rules around residential property and SMSF.

Can you use an SMSF loan to buy residential investment property?

You can buy residential investment property with an SMSF loan, including any established property that is a house, unit or townhouse. 

There are however some types of property you cannot invest in. Currently ATO regulations restrict you from:

• Purchasing vacant land with the intention of building on it.
• Building or constructing a new property.
• Purchasing or refinancing owner-occupied properties.
• Property for redevelopment and resale.
• Property purchased for the purpose of redevelopment. 
• Purchasing a friend’s house.
• Acquiring assets from a fund member or an associate of a member.  
• A holiday home you intend to use or lend to a friend.
• Overseas property.

Thinking of investing in commercial property?

Can you use an SMSF loan to buy commercial property?

You can buy commercial property with an SMSF loan, and there are unique benefits for your SMSF, as long as you meet the rules around this. 

You can occupy and lease a commercial property from your SMSF, which is not permitted for residential property.

Example: If you run a small business your fund can take out a loan to buy the commercial property used by your business, meaning you are effectively your own landlord. 

Just like applying for any other line of credit, when it comes time to apply for an SMSF loan you are going to have to meet lenders criteria.

Qualifying for an SMSF loan

Lenders look at a range of factors to determine if your fund can service, or repay, an SMSF loan. To qualify your fund will need to prove that: 

• It has a deposit of at least 20% of the property value.
• Rental income plus the super contributions that the members make should cover the repayments.
• Fund members have consistent patterns of contribution to the fund, to meet regular repayments.
• The fund is set up to allow direct investments in property. 
• The structure of the fund must be compliant with ATO and ASIC rules.

Now let’s look at some typical features you can expect an SMSF loan to have.

What features do SMSF loans have?

To give you an idea of what features an SMSF loan has we have summarised the features of our SMSF loan:  

• Interest rate type: Variable
• Loan size: $150,000 min - $2,000,000 max
• Loan term: 30 years
• Max LVR: Up to 80%
• Repayment frequency: Weekly/Fortnightly/Monthly
• Repayment types: Principal & interest or Interest only

In addition with our SMSF loan you can also make unlimited free additional repayments on your SMSF loan without being penalised. This means that you can pay off your loan faster than the agreed term and save on interest. 

We also have an optional 100% Offset Facility linked to your loan which allows your SMSF savings to lower the amount of interest you pay on the home loan.

4 things to do before you apply for an SMSF loan

It’s best to get organised before you start looking at properties to invest in, including:

1. Making sure your SMSF is properly set up 
2. Having all your contributions transferred into the SMSF
3. Getting pre-approval from your loan provider before your start your property search
4. Researching the market to target properties that are likely to achieve capital growth

Then you should be ready to apply for your SMSF loan.

Apply for an SMSF loan in 3 easy steps 

With Yard it's a simple, three step online application you can complete anytime, from any device.

Step 1: Tell us about yourself: Securely share your personal financial details. We verify your identity, credit history and financials online.

Step 2: Design your loan: Design the features of your loan to match what works best for you.

Step 3: Get approved! When all of your details check out, we provide you with the decision on your loan!

We then settle your loan and take care of the rest so you secure your property asap!

Armed with this knowledge about SMSF loans you should now be in a better position to decide if they suit your personal circumstances and investor profile. 

Have any questions about SMSF loans - or anything else related to investment property? Our local team are available to chat at a time that suits your schedule.