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News Bulletin : ADA News Bulletin December 2010
32 DECEMBER 2010 investment insight OTHER CONSIDERATIONS -- SPECIFIC TO SMSF'S ACQUIRING PROPERTY USING BORROWED FUNDS • The SMSF Trust Deed must permit borrowings; many older deeds do not. • Loans can include costs related to the acquisition of a property, including stamp duty, conveyancing costs and loan establishment fees. • Limited recourse borrowings are not allowed to be used to make improvements to a property already owned or newly acquired by a SMSF. Also, other funds within the SMSF or from personal sources aren't allowed to be used to make improvements as that could result in the property being deemed a non-allowable replacement asset. • With the exception of property used solely for business purposes, SMSF members are not permitted to sell a property they already own to their SMSF. Transfer of a business property into a SMSF is a capital gains tax event for the existing owner. • Assets, including property, already owned by a SMSF aren't allowed to be part of a borrowing arrangement so they can't be used to free up cash for new asset purchases or pension payments. • SMSF member contributions or other fund income can be used to meet loan repayments where rental income after expenses produces a shortfall. Note, the contribution caps may effectively restrict the ability to supplement rental income, if required. • If debt levels increase or interest rates go up the loan repayments will increase. This could adversely impact the fund's cashflow and potentially force the sale of the asset. • Gearing increases losses as well as magnifying gains. A gearing strategy may magnify the SMSF's losses if the investment decreases in value. In extreme circumstances the SMSF could lose its entire investment in the acquired asset. • If the SMSF defaults on it's loan this will possibly result in a financial loss to the SMSF and complications for the SMSF members if they are leasing the property from their SMSF as the lender may sell the property. • The ATO has said second mortgages are not permitted. • The cost of transferring business real property into an SMSF is a key consideration. Part of this cost is stamp duty which can be significant and is determined by state or territory legislation. • The NSW government has reduced stamp duty on the transfer of real estate into an SMSF to $50 if certain criteria are satisfied. In particular, the transfer has to be from one or more individuals, not a trust or company. If an in-specie contribution, care is required in relation to applicable super contribution caps. • SMSF members can occupy business premises owned by their fund provided they are leased at market rates. • The replacement asset rules are very restrictive and the ATO has said that a property destroyed by fire may not be allowed to be rebuilt, using insurance proceeds, if the loan is retained. This means a SMSF would need to use insurance proceeds to repay the loan and could not re-borrow to fund the costs of rebuilding. If the SMSF had inadequate funds available to rebuild it might be forced to divest the property. • Owning property through a SMSF can have advantages for investors looking to protect assets from anyone who might potentially sue them. IN SUMMARY Acquiring property investments through a self-managed superannuation fund can have significant tax advantages as compared with buying the same investment in personal names. This alternative should be examined by the over 800,000 existing SMSF members or any long-term investor considering the advantages of a SMSF. If you are considering this strategy seek professional assistance as any mistakes structuring SMSF property transactions can be very costly. This article has been edited due to space considerations. If you would like a more detailed version please contact the author. Parts of this article have been sourced from material produced by a professional fee based advisor Andrew Ramsay, an Authorised Representative of Financial Wisdom Limited. Neither Andrew Ramsay nor Financial Wisdom Limited have authorized or issued this article. Michael Lannon is the an Executive Director of 2020 Funds Management Limited trading as 2020 DIRECTINVEST, an ADA Partner Service specializing in the provision of execution only DIY investment services. Contact email@example.com or call 1800 352 021 or visit www.2020directinvest.com.au This article has been prepared without taking account of your objectives, financial situation or needs; and because of that, you should consider the appropriateness of the advice, having regard to the client's objectives, financial situation and needs. "Acquiring property investments through a self-managed superannuation fund can have significant tax advantages as compared with buying the same investment in personal names."
ADA News Bulletin November 2010
ADA News Bulletin February 2011