Buying real estate in your self-managed super fund


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Should your DIY fund invest in real estate? Money looks at the key questions

Financial advisers and friends are telling me I should buy residential real estate for my self-managed super fund (SMSF) and that it is a better investment than shares. Are they right?

It depends whether the value of the property you buy with your super fund money delivers a better return and capital gain than an investment in shares and other assets.

If you have a large fund of over $1 million, property might provide a good balance to a more volatile sharemarket, but it should not represent your total super fund portfolio. It should soak up no more than 50% of your fund's value.

The property markets in some areas - in Melbourne, Sydney, Brisbane and Perth in particular - have been hot over the past 18 months, but it is anyone's guess whether values will continue to rise as rapidly over the next few years.

And you should be looking at about a 10-year investment for a super fund. Nevertheless, property is viewed as a more stable investment than shares in the current economic climate.

Are there tax benefits when holding property in a super fund?

The main advantage is that the fund pays no tax on rents or on capital gain when the property is sold if you are retired or aged 60-plus, and little tax if the fund is in the accumulation phase.

The property bought can be leveraged but the tax benefit is limited, as any rental income losses can only reduce a maximum 15% tax (the maximum tax rate charged on any super fund investment gains).

In the drawdown phase there is no tax payable so any negative gearing losses are worthless from a tax viewpoint. Seeking a tax advantage would not be a good reason to invest in property.

An SMSF adviser said that if the negative geared amount is $2000 to $3000 a year on an $800,000 property, it might still be worthwhile holding, as the lost "benefit" of negative gearing is relatively marginal.

You would expect capital growth over a 10-year period to outstrip the negatively geared loss. But if the loss is $20,000 a year, it is much less likely to be a sustainable strategy.

Can I borrow the whole amount to buy property for the fund?

Lenders generally limit the borrowing to a maximum 80% of the value of the property held by the fund and the only security for that loan can be the property itself.

Lenders cannot take security over any other assets of the fund or seek to recover from these other assets if the loan goes bad.

Should the purchase be limited to the accumulation phase or can I also buy property for the fund once I have retired?

It's rarely sensible to borrow money to invest when you are in your 60s, let alone when you are retired. Storm Financial clients learnt that lesson the hard way.

It's worth remembering that loans carry an interest cost that has to be paid for from somewhere, either rental income or another source. Property also involves other acquisition and maintenance costs.

Most likely these will come from other investment income if the rental earned on the property is insufficient to cover costs. That reduces the overall income from your investment portfolio and may or may not be made up by any capital gain when the property is sold.

Can I put my daughter into the house and charge her reduced rent?

Tenants must be at arm's length. No family members are allowed to be tenants.

If they were, the fund would be breaching superannuation investment rules and the sole purpose test, so the tax office might remove any tax concessions available to the fund and tax its earnings at the top marginal rate.

What else should I consider?

Diversify your investment portfolio. If the property purchase represents nearly all your fund's value, think again. No fund should have only one asset.

While property can be sold, it takes time.

So if you hit an emergency requiring a significant drawdown from your fund and the property is the main asset from which that drawdown must come, you face having to sell the whole property in a hurry, when the market may not deliver the best price.

You would be wise to take expert advice before deciding to purchase property for your fund.

At all costs avoid buying from property spruikers who may be offloading hard-to-sell properties in bad property markets on unsuspecting investors.

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