This month I share with you some of the most common mistakes I see people making when they purchase property in their Self-Managed Super Fund (SMSF).
Your Self-Managed Superannuation Fund can borrow money to
a) Purchase a property (including all acquisition costs),
b) Pay for repairs and maintenance and
c) Capitalise interest.
You cannot use borrowed funds to improve the property. Improvements include additions, granny flat, extensions etc. For these activities cash resources of the fund must be used. It is critical to keep good records in your SMSF to identify whether borrowed funds or internal cash is used. When debt is used, the property must be held in a Holding Trust with a Corporate Trustee and not directly in the SMSF.
Apart from the legislative requirement to not hold the property in the SMSF there are real and practical reasons why you would not want to hold it in the SMSF.
2. Associated Party Loan
Many people use external funds to assist them in purchasing property in their SMSF by contributing the cash as a non-concessional contribution. The problem is that once contributed you cannot get the funds back until retirement or worse still you cannot put in sufficient funds within the allowable limits. You can however lend the funds to your superannuation which allows its release if refinanced and there is no limit on the amount of the loan.
The mistake that many people make is to lend the funds with a simple loan agreement. The loan agreement must meet the limited recourse borrowing requirements of the legislation as well as clearly identifying all terms and conditions.
Renovations which merely return the component back to a new condition are classified as repairs for the purposes of the superannuation borrowing legislation. Therefore a cosmetic renovation which replaces the existing kitchen or bathroom is allowable even with borrowed funds.
The mistake often made is to improve the kitchen by say extending the bench area or knocking down a non-load bearing wall. The latter two are deemed to be improvements and must use internal SMSF cash. It is a simple matter to ask your builder to split the invoice to show the improvement as a separate piece of work which can then be funded with cash and not borrowed funds. If a property is demolished and say a duplex is built or land is initially purchased and then a separate contract to build is entered into then these are changes to the original asset and cannot be done within the SMSF while there is still an outstanding debt on the property.
4. Life Insurance
Life insurance premiums are tax deductible in super. A common mistake is to assume this is still valid if the SMSF fund takes out a policy to repay debt on the death of a member. It is not. For the premiums to remain tax deductible they must not relate to the specific use to pay down the debt. Insurance to effectively achieve the same outcome and be tax deductible is possible with the correctly worded SMSF and policy identification.
5. Stamp Duty
When the debt is paid down the property must be transferred from the holding trust into the SMSF. Many states will charge stamp duty at the full property transfer rate. With the initial use of additional documentation at the time of purchase the second stamp duty trap can be avoided.
6. Purchasing from a member
While the SMSF can purchase a residential property from a non-related third party, it cannot purchase a residential property off a member or related person of the member. An SMSF can however purchase listed shares or business real property (commercial and industrial) off a member. There will be CGT and stamp duty consequences to the sale but in relation to stamp duty most states allow for a minimal stamp duty if the property is in the individuals name and they are also the SMSF member..