5 things you need to understand before buying property with super

This blog originally appeared on Easy Super SMSF Accounting & Consulting's blog.

If owning an investment property seems to be a distant dream, it might be time to turn to super money to make it a reality.

But you will need to understand some of the complexities about buying property with super before deciding if it’s right for you.

Below are five points to bear in mind before going any further…

1. Establishing your SMSF and a property investment strategy

A self-managed superannuation fund (SMSF) is a trust, where the money is held by the trustee of the fund for the retirement purposes of the members.

In SMSFs, the members of the fund are usually the trustees or directors of the trustee company too. Therefore, they are in control of where to invest the fund’s money.

SMSFs are governed by the Superannuation Industry (Supervision) Act 1993 (SISA). It is a responsibility of trustees to comply with this Act and the other rules and regulations concerning SMSFs. There are specific super and tax rules and regulations, which the trustees have to comply with when investing their money.

If you don’t already have an SMSF, the first step will be to establish one. We have a comprehensive e-book covering the steps required to do this and also to invest in property.

After setting up your SMSF, you will need to formulate an investment strategy to decide where to invest the super money. SMSFs are allowed to invest in residential or commercial property.

2. Understand the investment restrictions when buying property with super

With SMSFs, any investment property must be purchased and maintained on an “arm’s length” (commercial) basis.

As such, SMSFs are prohibited to acquire an asset from a related party. Sections 70B and 70C of the SIS Act define the related party which, in broad terms, are relatives, business partners, and companies which are controlled or majority-owned by any of the members.

Therefore, the trustee of the SMSF cannot buy a residential property from a related party, such as a member of the SMSF, their relatives, a business partner, or controlled company or trust.

If a trustee wants to invest in residential property, the property must be bought from an unrelated party at market price and also rented out at market price.

The trustee of the super fund will become the owner of the property. Trustees and related parties are prohibited from living in a residential property owned by the SMSF, as it will contravene the “sole purpose test”, which is that the fund needs to be maintained for the sole purpose of providing retirement benefits to the members. The property must be rented out to an unrelated party.

3. Understand the exemptions

The exemption from the “related party rule” is a commercial or business real property, which could be acquired from a related party and leased back to the related party, again subject to dealing at “arm’s length”.

As mentioned, Section 109 of the SISA requires investments of a superannuation entity to be made on an “arm’s length” (commercial) basis.

All dealings must be conducted in the same manner as if both parties were unrelated. For example, the members of the SMSF can run a business from the property owned by the SMSF, subject to a lease agreement and the rent being at “arm’s length”.

4. When can you live in your property?

After buying property with super, the SMSF members can only start living in it after retirement.

The property can be transferred out from the SMSF as a pension payment. When it leaves the superannuation fund, members of the superannuation fund are free to start living in it.

There is no rule prohibiting the trustee of the SMSF from selling the residential property to the members, which again should be at “arm’s length”: that is, at the market rate at the time of the transaction.

Note that this transaction could be subject to capital gains tax and stamp duty payable by the buyer.

5. What to do if you don’t have enough in your super for buying property?

If members of the SMSF don’t have enough money in the fund to buy property outright but do have enough money for a deposit, there is an option to borrow.

As a general rule, SMSFs are prohibited from borrowing under the SIS Act. However, Section 67 of the Act allows SMSFs to borrow under a limited recourse borrowing arrangement (LRBA).

In this arrangement, the property is held by the lender as security but the other assets of the SMSF cannot be used as the security.

The LRBA rules are complex and require the establishment of a holding trust (bare trust) with corporate trustee. The bare trust will be the registered holder of the property until the loan is repaid and the super fund is a beneficiary of the trust.

If you are considering buying property with super, we can help. At Easy Super, our first consultation is absolutely FREE and can be done over the phone. We can provide the general information you need, and answer your questions about SMSF and property investing to see if you want to explore the option further.

The above information is provided as an information service only and, therefore, does not constitute financial product advice and should not be relied upon as financial product advice. None of the information provided takes into account your personal objectives, financial situation or needs. You must determine whether the information is appropriate in terms of your particular circumstances. For financial product advice that takes account of your particular objectives, financial situation or needs, you should consider seeking financial advice before making a financial decision.