On 24 September 2007, legislation came into effect that allowed self managed superannuation funds to borrow money to acquire certain assets permitted under Superannuation legislation through a properly structured limited recourse arrangement.  For the first time, investors now have the ability to enjoy the advantages of borrowing to purchase property inside superannuation, such as:

• The ability to use your current superannuation balance as a deposit;
• The ability to use your superannuation contributions to service the loan.  This not only includes your employer contributions, but also your salary sacrificed contributions, effectively giving you a tax deduction for the whole repayment, not just the interest;
• Concessional rate of tax on income in superannuation of 15%, and zero in pension phase means you can use your tax savings to claim ownership of your property much sooner;
• Concessional rate of capital gains tax in superannuation of 10%, and can be zero once you have commenced a pension.  It represents a great way to purchase a future holiday home as you can also significantly reduce any unrealised capital gains tax liabilities.

Before you choose to purchase property inside superannuation using a limited recourse borrowing arrangement, you should first pay close attention the following important considerations:

• Ascertain whether this strategy is suitable for you….you should have at least a 30 percent deposit in superannuation to give you breathing space in the event of non-tenancy and also ensure the fund will be able to achieve the necessary levels of liquidity and diversification. You should also consider your age and risk profile;
• Establish a self managed superannuation fund, or if you already have one, engage a specialist to ensure the fund’s trust deed allows the fund to enter into a borrowing arrangement and the investment strategy allows the fund to invest in direct property;
• Work with your solicitor to set up the necessary documentation and holding trust (custodian).  This is critical as the property will need to be in the name of the custodial trustee rather than the superannuation fund or the actual names of the investors;
• Obtain finance pre-approval, either bank finance or self-funding.  Be aware self managed super fund loans are different to ordinary loans, and the use of a broker would assist greatly;
• Source a suitable property for purchase.  It is advisable to obtain a property that requires minimal repairs or improvements. The tax office recently released a draft tax ruling SMSFR 2011/D1 that clarified that it is possible to improve the asset provided the fund uses its own money rather than borrowed money (such as installing a swimming pool or new kitchen);
• Once a suitable property is found and a purchase price negotiated, all documentation will be completed and executed and the purchase contracts signed in the name of the custodial trustee. The bank will provide the finance and the property is now settled;
• Obtain adequate insurance cover, both for the property and also adequate life / TPD cover.  This is essential as some lenders may call in the loan on the death of a member;
• The fund must report to the ATO each year and the trustee must ensure the fund is complying with superannuation regulations at all times.

Care must be taken if you are to embark on this strategy, as mistakes are easy to make and time consuming and expensive to fix.  For a confidential discussion on how we can assist you with a limited recourse borrowing arrangement, call Power Wealth Management today on 1300 975 224

SCENARIO 1 – SEA CHANGER

Chris (50) and Lorraine (48) wish to retire down the coast when they retire in 15 years. While on holiday down the coast, they stumble across the perfect unit located opposite the beach. They would love to purchase the unit, but have insufficient income capacity to do so.

Personal situation

• Their home is worth $500,000 with a $300,000 mortgage;
• They also have $375,000 of combined superannuation;
• Chris earns $80,000 per annum plus super while Lorraine earns $40,000 per annum plus super;
• Their living expenses are $5,000 per month;
• The asking price of the unit is $500,000, forecast to generate $500 per week in rent.

Strategy

• Chris and Lorraine can establish a SMSF and pool their superannuation;
•  The SMSF borrows 75 percent of the purchase price ($375,000);
• Chris and Lorraine’s employer super contributions, SMSF investment income and rental income can be used to service the loan.

Results

• Chris and Lorraine are able to purchase the beach unit without a personal deposit and without affecting their personal cash flow;
• If Chris and Lorraine retire just before Chris turns 65, they can sell their current home, contribute the proceeds to the SMSF (up to $900,000), commence a pension for both of them, then withdraw the beach unit from the SMSF free of capital gains tax and stamp duty.

Assumptions

• For a $300,000 mortgage at a 7.5 percent interest rate, repayments of $2,777 pm are required to pay off the mortgage by the time Chris turns 65;
• Purchasing and set up costs would be approximately $25,000, paid by the fund;
• Assuming the property is let for 45 weeks and has annual expenses of $6,000, the net rental income would be $16,500;
• Combined employer super contributions are $10,800 and an income yield of 6 percent is applied to the remaining $225,000 of investments in the fund (generating $13,500 income);
• The total income of the fund would be $40,800, while the repayments on a 15 year loan (principal plus interest) at 8 percent would be $2,867 per month.

SCENARIO 2 – SELF-EMPLOYED DOCTOR

Jim is a self-employed doctor currently renting his office. He would like to own his business premises to provide certainty around his rental agreement. He makes an offer for the premises he is working from of $250,000.

Personal situation

• Jim pays himself a salary of $100,000 plus 9 percent super;
• The business (a company) pays $400 per week in rent ($20,800 per annum);
• Jim does not have sufficient funds to purchase the office, however he has $150,000 in superannuation.

Strategy

• Jim can establish a SMSF to purchase the property;
• The SMSF can borrow up to 65 percent of the purchase price ($162,500);
• Jim’s company to now lease the property from the SMSF;
• The rent can be used to service the loan repayments while Jim’s super contributions can be used to cover any property expenses.

Results

• Jim will now pay the $400 per week rent to his SMSF, effectively becoming his own landlord;
• Jim now uses super to provide for his retirement, something few business owners manage to do;
• The strategy will deliver a tax advantage to Jim of $6,240 per annum;
• When Jim turns 55, he will be able to commence a pension from the SMSF. If he does so, any income or capital gains earned from the fund will be tax free.

Assumptions

• Purchasing and set up costs would be approximately $20,000;
• Loan repayments of $1,645pm ($19,740 pa, assuming an interest rate of 9 percent and a 15 year term, principal and interest);
• Jim’s business receives a 30 percent tax deduction for the rent, but the tax rate of his SMSF is only 15 percent. As the interest on the loan, depreciation and any property expenses are tax deductible to the fund, the fund will effectively pay no tax on the rent.

SCENARIO 3 – DOUBLE INCOME EARNER

Mike (45) and Michelle (45) wish to purchase an investment property for $400,000. They find an ideally located townhouse which has an estimated rental income being $400 per week.

Facts

• Mike earns $80,000 p.a. plus super and Michelle earns $40,000 p.a. plus super working part time
• Their only assets are the family home worth $500,000 (which has a $250,000 mortgage) and combined super worth $125,000

Strategy

• Mike and Michelle can purchase the property in a SMSF
• The Fund can borrow up to 80 percent of the purchase price ($320,000).
• Mike and Michelle’s employer superannuation and fund investment income are used to make the loan repayments in the SMSF. Mike also sacrifices $10,000 of his salary to super;

Results

• The total cost to Mike and Michelle using super is $571 per month;
• If the same property was purchased in Mike’s name (to maximise the tax effectiveness) with the same loan, the total cost would be $1,054 per month;
• The value of the property would be worth $1,061,319 when Mike and Michelle retire at age 65;
• If the property is sold, the proceeds if held in the SMSF would be $1,034,786 (no tax if in pension phase) and $913,648 if held in Mike’s name (due to capital gains tax payable of $121,138 based on today’s tax rates).

Assumptions

• Purchasing and set-up costs would be approximately $20,000;
• Assuming the property is let for 45 weeks and has annual expenses of $6,000, the net rental income would be $12,000;
• Mike and Michelle’s superannuation from their employer is $10,800;
• The total income of the fund would be $22,800, while the repayments on a 20 year loan (principal plus interest) at 8 percent would be $2,673 per month;
• Mike needs to sacrifice $10,000 per annum of his salary to superannuation, so the total income of the SMSF will increase to $32,800, necessary to cover the repayments of $32,076;
• The total cost to Mike and Michelle represents the salary sacrificed to super;
•  The total cost of property purchased in Mike’s name inclusive of a tax deduction of $7,434 (assuming a 2.5 percent building allowance). It is important to note the SMSF receives the same tax deductions, but this is almost offset by the superannuation contributions of $19,900;
• Annual growth rate of 5 percent per annum;
• Selling costs of 2.5 percent.

SCENARIO 4 – SOLE INCOME EARNER

Susan (40) is married to John (40) and is interested in building wealth through property investment. They find a unit close to the City for $450,000, paying $450 per week in rent.

Facts

• Susan is the sole income earner in the household earning $150,000 per annum plus super;
•  Their assets are the family home worth $500,000 (which has a $250,000 mortgage) and super of $150,000;

Strategy

• Susan can purchase the property in a SMSF;
• The Fund can borrow up to 80 percent of the purchase price ($360,000);
• As Susan already receives superannuation from her employer of $13,500, this can be used to make the loan repayments in the SMSF.

Results

• The total cost to Susan using super is $293 per month;
• If the same property was purchased in Susan’s name (to maximise the tax effectiveness) with the same loan, the total cost would be $696 per month;
• The property would be worth $1,523,860 when Susan retires at age 65
• If the property is sold, the proceeds if held in the SMSF would be $1,485,763 (no tax if in pension phase) and $1,271,398 if held in Susan’s name (due to capital gains tax payable of $214,365 based on today’s tax rates).

Assumptions

• Purchasing and set-up costs would be approximately $25,000;
• Assuming the property is let for 45 weeks and has annual expenses of $6,000, the net rental income would be $14,250;
• The total income of the fund would be $27,750, while the repayments on a 25 year loan (principal plus interest) at 8 percent would be $2,776 per month;
• If Susan sacrifices $6,000 per annum of her salary to superannuation, the total income of the fund will increase to $33,750, necessary to cover the repayments of $33,312;
• The total cost to Susan represents the salary sacrificed to super;
• The total cost of property in Susan’s name inclusive of a tax deduction of $10,707 (assuming a 2.5 percent building allowance). It is important to note the SMSF receives the same tax deductions, but this is almost offset by the superannuation contributions of $18,960;
• Annual growth rate of 5 percent per annum;
• Selling costs of 2.5 percent.