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Want to gain more control over your super? Setting up an SMSF can be the solution you are looking for – a self managed superannuation fund where you take charge of your investments.

A sound investment strategy holds the key to a happy retirement. Through a self-managed superannuation fund, you have the option to invest not only in shares, collections, deposit, but property as well. In fact, with the 2007 amendment allowing SMSFs to borrow money to finance assets, acquiring property through SMSF has become a popular trend.

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While holding a property in your SMSF portfolio offers you tax concessions on rental income and no taxes in the pension phase on rental income and capital gains, the process of borrowing money via SMSF is a complicated one and understanding the basics can help you decide whether the strategy works for you or not.

The rules

 Sole purpose test – All assets held by the trust must be for the sole purpose of funding your retirement.

Legal framework – The property cannot be held in the name of the SMSF but a special purpose test created for the purpose.

Arms Length Transaction – The property must not be bought, lived in, or rented by a fund member or their related parties.

Commercial properties – It is possible to acquire a commercial property for your business through your SMSF and directly pay rent to the SMSF at prevailing rates.

The costs

Financing through SMSF can be more expensive than a routine home loan. Most lenders ask for minimum 20% deposit, along with which a host of fees such as legal fees, property management fees, stamp duty, bank fees and upfront costs needs to be paid out of your super.

This means you are spending at least 30% of the purchase price from your super. Do not forget the cost of setting up the SMSF as well.

The financial arrangement

An SMSF can fund the property purchase through fund money and borrow the remaining under a Limited Recourse Borrowing Arrangement.

If you have 30% of the purchase cost in your fund, you will find many LBRA loans for your SMSF. However, these are complicated financial arrangements and it is best to seek expert advice before entering into one.

Typically, under LBRA, the asset is held by a special purpose trust (other than the SMSF) as Security Trustee for the lenders. The rental income is directly used to make the repayments and in case of default, lenders’ recourse is limited only to the asset held under the special purpose trust.

Potential pitfalls:

High interest rates – Loans to SMSFs come at higher interest rates than usual property loans.

Paperwork – The paperwork involved is heavy and in case you get it wrong, it may be hard to unwind the structure, leaving you only with the option to sell the property and scoring loss.

Events of default – Lenders reserve the right to review LBRA loans from time to time. Thus, a lender may decide to review the loan in case of a new birth in your family, a change of job, any decrease in property price or change of circumstance and cancel the loan at any time in case it fears you no longer can repay the loan.

Cash flow crunch – As the fund money is engaged in making repayments, cash flow problems may occur for meeting regular outgoings leading to penalties.

Key points to remember:

  • Don’t compromise on the property research. Ask for a free property report to know the property dynamics in your favourite suburb before you buy.
  • Choose a positively geared property in an area of potential growth.
  • Do not buy property for tax benefits. Have a clear investment strategy in mind.
  • Rules for buying commercial and residential property are different. Know the rules before you buy.
  • Don’t hesitate to take expert advice. 

HashChing lets you compare hundreds of pre-negotiated deals at competitive rates online. Whether you are looking to finance or refinance your home, get in touch with HashChing experts to simplify your home loan.

 

By Vidhu Bajaj

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