Hi SNM

I think that Richard has provided some good information, however since I have also had a fair amount of experience with assisting my clients purchase property via their SMSF and utilising I would like to add a few points to assist in blue.

a) Is there a restriction as to the type of property that can be bought in a SMSF? eg: block of 3 or 4 villas/townhouses vs strata retail shop vs single dwelling?

Yes and No. There is no restiction as to the type of property that can be owned within the fund as long as the Trustees have considered the risk and the acqusition forms part of the overall investment strategy. No being the fund cannot borrow to fund such a project.

There is a a general prohibition of SMSFs borrowing directly.  However, since September 2007 SMSFs have been able to borrow under an 'instalment warrant' arrangement which basically means a separate trust and trustee hold the title of the property and the SMSF receives all income and pays the loan repayments. See diagram below:

b) Is a smsf liable for land tax? Does it benefit from a tax-free threshold for land tax or is it added to my land holdings?
Yes a SMSF is liable for Land Tax and normally would not benefit from any Tax free threshold. May vary from State to State but is payable in Qld on every dollar.

Check with the state revenue office in the state(s) the property(ies) will be located.  In QLD land tax is only payable where the unimproved land value is more than $350k.  Property owned by a SMSF (directly or via an instalment warrant) is taxed for land tax purposes as a trust.   http://www.osr.qld.gov.au/land-tax/about-land-tax/land-tax-rates.shtml

Also, recent changes to the SMSF borrowing rules mean that a separate trust & instalment warrant must be used for each property (separate titles) – even if they are identical – which means each property should have its own land tax threshold. Once again check with your state revenue office for details.

c) Can the smsf sell the properties?

Yes of course. Remember a SMSF cannot be seen to Trade so would be hard to argue if you did it repeatedly.

As per Richard.  The SMSF cannot be seen to be in a property selling business or property development business as this is a breach of the SIS rules.

d) Can the smsf undertake works/value add? Can the fund borrow to undertake these works?
Again Yes and No. Nothing to stop the fund improving or renovating the property but is unable to borrow full stop. (To clarify a SMSF cannot borrow in it own right)

OK, this is a tricky one.  This is one of the questions that the ATO have been asked:

Can an SMSF trustee draw down under a limited recourse borrowing arrangement to make capital improvements to real property held by the holding trust under that arrangement without contravening the super law?

Yes under the current law. Improving real property involves changing the property into a more desirable or valuable form – for example, by extending the property's income-producing ability, or enhancing its saleability or market value. When improvements materially alter the character of the original asset, they create a replacement asset for the purposes of subsection 67(4A) of the SISA. Under subsection 67(4A), the replacement asset is not limited to any particular type of asset but must be an asset that the SMSF trustee is not prohibited from acquiring. Assuming that the original property was an asset that the SMSF trustee was permitted to acquire, the improved property will be a permitted replacement asset.

If the terms of a limited recourse borrowing arrangement allow the SMSF trustee to make drawdowns, then any drawdowns must be used for the acquisition of the original asset or its permitted replacement.

Drawdowns to pay for capital improvements to the original asset meet this test, as do drawdowns to capitalise interest, maintain the asset and meet other costs of the arrangement. However, an SMSF trustee cannot make a drawdown to extract cash from the arrangement.

Even though the ATO has said borrowing to make capital improvements to a property owned by a SMSF via an instalment warrant arrangement (holding trust) is OK, in reality it will be difficulty finding a lender who will take this type of lending on.  You can work around this by utilising extra contributions to the SMSF to fund improvements.

e) Who borrows on behalf of the smsf – do I have to borrow as trustee or can the fund borrow funds? Are the borrowings at a commercial rate or a investors rate (or the best rate that I can negotiate)?
You cannot borrow for such a venture so question is easily answered. In saying that if the fund invested in a Unit Trust and the Trust (with totally unrelated parties) borrowed funds then this is different.

When talking about borrowing via an instalment warrant arrangement, it is the SMSF which is the borrower.  The trustees of the SMSF can also borrowing themselves (in their own capacity – NOT in their capacity as trustees of the SMSF) and on-lend to the SMSF.  This is termed 'member financing' and can often be easier to obtain if the trustees have available equity in other properties.

In terms of the rates, there is a lot of variation.  Some lenders have been been charging a premium on top of their normal interest rate, however this seems to be changing.  For example I have heard that from 1 July 2010 Westpac (one of the bog banks that do a lot of SMSF loans) will be charging the same rates for SMSF loans as normal investment property loans.  There also might be different LVRs – i.e. slightly lower.

f) If I have to borrow on behalf of the fund eg I own 50% & SMSF 50% (fund has applied its funds towards purchase and not borrowed, I have borrowed 100%), is there an optimum way of structuring ownership or only as joint tenants (would tenants in common mean that if I Passed away the property would automatically pass to the SMSF)?
As long as the property was used as security this would be ok. You borrowed using your PPOR for example. Ownership structure is not that simple unfortunately.

To elaborate: If the property is owned by the SMSF directly (i.e. legal title owned by the SMSF directly) then that property cannot be used as security for any borrowings.  Likewise when the property is owned via tenants in common – as the lender cannot mortgage against only 50% of the property – they have to have security over the full title.

Based on the information you have provided, it may be possible for you to borrow and on-lend of the SMSF using a line of credit or loan against existing equity you already have.  You will still however need to set up the same custodian trust/holding trust to hold the legal title of the property and have appropriately drafted loan documentation.

However, I believe it is preferable to utilise the bank as a direct lender and keep any equity you have available for other investments outside of the SMSF – especially if the SMSF has around 50% of the target property purchase price – the bank lending / approval process should be easy.

g) Is there a restriction on how much (%) the fund can borrow? (the investment will be positively geared with minimal  borrowings ie < 20%). Yes Nil.

There is no limit under the superannuation regulations.  However each bank will have a maximum LVR (loan-to-value-ratio) – typically 80%.  I have found that with residential property you need to provide between 35% and 40% of the purchase price to get the property to be cash flow positive before taking into account any tax advantages.

h) Is the fund subject to CGT discount if the asset is sold pre-retirement age?
Yes the concessional rate of CGT for a SMSF is 10%.

As Richard said, if the property has been owned for more than 12 months, the gross capital gain will be taxed at 10% – which will be significantly cheaper than the CGT if it was held in your personal name or even in a trust.

If any investments of the SMSF are used to support a pension, then the income and capital gains from that investment are tax exempt.  If you have a SMSF that is 'multi-generational' (i.e. parents and adult children in the same SMSF) then there are some awesome tax planning strategies that can potentially be utilised to wipe out any CGT – even if the property actually 'belongs' to the kids rather than the older, retired parents.

i) Can the fund appoint a property manager & pay their fees for management? Does the agent have to be a non-related party ie not a beneficiary of the fund eg PTY LTD company? Yes the fund could use a local propery manager to perform the duties of management but would need to be a non related party. Could not be a Trustee of the fund.

Once the SMSF has purchased a property (utilising an instalment warrant structure or not) then it basically runs exactly the same as an investment property held in your personal name.  This means the SMSF gets all the rental income and also has to pay all expenses including property manager fees.

The agent could be a related party (i.e. if the members of the SMSF are real estate agents / property managers) and everything was done at arms length / market value.  The SMSF can also reimburse the trustees/members for any expenses incurred by them on behalf of the SMSF, however the SMSF cannot pay the trustees simply for being a trustee.

In summary, if you are in the property management business and your SMSF property is treated exactly the same as other clients of your business then you will be fine, otherwise the ATO could interpret it as a sham arrangement for the members to derive a benefit before they retire.  This is the same if you pay a related Pty Ltd company.  

j) Can a beneficiary undertake the work & be paid by the fund? (eg if licenced builder is not required for non-residential works)
No.

See above.  If you can validate the amount paid by the SMSF via alternative quotes then you may be OK – but I suggest seeking paid professional advice if you are unsure.

k) Does the fund need to divest of the assets upon the death of one of the beneficiaries if there is insufficient cash to pay out the account? Not sure i understand the question but if you are saying that the Deed allows for a lump sum payment upon the death of one of the Trustees (Maximum 4) then Yes assuming the Fund does not have any other cash assets (this in itself would probably fail the Annual Audit regards to investment practise) the property would need to be sold.

Very very good question – and I bet a question most people (even those who have property investments in their SMSF) have NOT asked! 

This is a complex area that probably deserves an entire post to itself – some points however:

– Yes – if there is insufficient cash and a lump sum benefit has to be paid, then the property would need to be sold to fund the lump sum death benefit payment

– If it is a typical mum & dad SMSF and one partner dies, then the surviving spouse can take the benefit as a pension – meaning provided there is sufficient cash flow from the property to pay the pension, the property would NOT need to be sold

– Life insurance policies can (and SHOULD) be taken out by the SMSF on the members and the cash from the proceeds of the policy can be used to pay the death benefit rather than having to sell the property provided that the SMSF has appropriate documentation such as a quality trust deed (not a $99 or $199 deed), a SMSF estate plan, minutes and the ability for the insurance proceeds to go into a 'reserve' within the SMSF rather than simply added to the members account

– This is a complex area and it is essential you seek advice from an appropriately qualified SMSF specialist

l) Who would be best to set up the smsf – solicitor, accountant or accountant with legal advice or solicitor with finanical advice?
A good Accountant could set up the Deed however think you might need all 3 depending on what you eventually decide to do.

Once again a very good question.

Most accountants can easily set up an SMSF, however only a small % also have the necessary qualifications and experience regarding SMSF loans to be able to get the structure set up correct and (most importantly) get the finance approved with your chosen lender and get it through their solicitors.

A couple of points:

– Find an accountant that is also a SPAA specialist advisor (search here: SPAA)

– Ensure that they use a trust deed and SMSF loan documentation (instalment warrant documentation and holding trust a.k.a. debt trust / property trust / custodian trust) that has previously been approved by your chosen or recommended lender

– It is strongly suggested that you utilise companies as trustees for both your SMSF and your holding trust

– Costs vary, however cheaper is definitely NOT better when it comes to SMSF borrowings – however for the HUGE amount of tax savings and superb asset protection it is definitely worth it – and these costs are paid by your SMSF

Scott – I hope you find the above information helpful.

If you (or any other PropertyInvesting.com readers) have any questions please do not hesitate to post them – chances are others will have exactly the same questions.

Thanks

Evolve

GST is only applicable on the first time sale of brand new residential property.

It would pretty much need to be knock-down and rebuild to be significantly / structurally different to be considered a new residential property.

No GST issues for most renos.

E

Hi iball,

Sounds like a pretty great profit you would make.

I understand that you may want to crystallise the price now.

Dwolfe is correct – after the rebuild you will be selling 'new residential properties' so you will have GST on the sale price.  You need to take this into consideration.

In terms of the structure, maybe a trust with a corporate trustee would be a good way to mitigate some of your risk relating to the mini-development – however to make the transfer happen (i.e. from your name to the trust) you will need to incur stamp duty on the transfer.

I believe you need some good advice from an appropriate qualified accountant.  They can help you plan and work out the best way to protect yourself while giving you some advice on minimising the tax liabilities.

CGT can be planned for and work with – provided you get advice in advance.

And remember – if you are paying some tax, then it means you are making money!

Good luck with everything
Evolve

Have you thought about using an SMSF?

If structured correctly you can get the best of both worlds i.e. lower tax when you sell plus lower tax all the way through – regardless of whether it is positive or negatively 'geared'.

Want to know more? If so let me know.

Cheers
E

Rebecca,

With an issue like this you need to seek paid professional advice. 

You cannot simply make the capital gain go away by building and making it your PPOR.  It will be proportionate.

With some planning and a better overview of your situation a good tax accountant should be able to significantly reduce your CGT bill.

Where are you located? Maybe I can refer someone.

Kris

Each dealer group that holds an Australian Financial Services Licence (AFSL) determines the minimum education + competency requires for their individual authorised reps.

The dealer group my employer is with requires the Diploma of Financial Services(Kaplan – first 4 subjects) as the minimum, but other groups take into consideration other education and experience.  For example I knew someone who sold timeshare and she became an authorised rep via doing a very simple test – but she was limited to advising on specific products.

The 4 first subjects that make up the DFP are relatively easy – especially if you have completed a Bachelor with any kind of commerce / finance major.  You could probably even see if any financial planning companies are offering cadetships / work experience placements – check their websites.

I beleive a Bachelors degree with a finance major + DFP is probably going to serve you better than a masters.

I hope this helps.

To answer your question it basically works proportionately.

But you should invest in something because it is a good investment – not because of the tax benefits.  Try to think as the tax benefits as the cherry on top.

Good luck

The actual CGT is often not as much as people expect.

Talk to your account BEFORE signing a contract and see if anything further can be done in advance to reduce your taxable income and hence reduce the additional tax when the capital gain is lumped on top of your other taxable income.

In QLD you will probably have to send forms off to the Office of State Revenue to get is stamped as $NIL transfer duty payable before sending anything off to those 'people' at the Titles Office.

See if you can get your ex to pay for a conveyancing – you may be able to save some further heartache.

Onwards and upwards!

Yeah – although lawyers like to believe they know everything it is difficult to find a general lawyer who also keeps up to date on tax law.

Maybe try to find a great property / conveyance lawyer who works closely with a great tax accountant and you will get the best of both worlds.

I am an accountant who has been trained on structuring by lawyers – I don't proclaim to know everything but can normally point someone in the right direction.