How To Use Your Super To Invest In Property
Wednesday, December 2 2009
Australians love property. In fact, 1 in 5 households own an investment property but less than 4% have used their superannuation to buy one. This means that many people are missing out on the compelling opportunity to invest in direct property through super and thereby minimizing tax to nil for retirement. Imagine selling your investment property in retirement, say in 30 years’ time, and not having to pay any capital gains tax.
In principle, superannuation funds are not allowed to borrow. This leaves many superannuation funds with smaller balances stranded simply because they can't afford to invest in big lump sum items like property. More recent changes to super legislation, however, have introduced an exception to the rule and direct property investing is now available to almost everyone provided you use a Self Managed Super Fund (SMSF).
A SMSF is still not allowed to borrow but if a specific investment vehicle like a property warrant is being used it is allowed to acquire an investment by instalments. Each instalment goes towards the purchase price until the property is fully paid off.
How does it work?
Let’s make an example. The ABC family SMSF wants to invest in a property worth $400,000 but has only $150,000 cash available which is the combined balance from the four family members.
The SMSF pays a deposit of $120,000, i.e. the first instalment. This equals to 30% of the property purchase price. The SMSF applies for a super loan from one of the major lenders for the remaining 70% or $280,000 of the purchase price. The required minimum deposit amount will vary depending on the chosen lender's gearing policy. The SMSF also pays the purchasing costs of, say about $20,000, covering loan costs, legal fees and stamp duty. This leaves them with cash reserves of $10,000 of the initial $150,000.
Once the super loan is set up, the cash flow of the super fund must be able to pay the interest on the loan, any periodic loan repayments and associated costs with the investment property such as maintenance, repairs, council rates, etc. Neutral to positive gearing models are the most favourable strategies here unlike negative gearing in personal names.
Minimum repayments on the SMSF loan are set by the lender and are seen as instalments. The ABC family SMSF receives contributions from all the employers of all the members at a rate of 9% of their salaries. The fund also receives rent from the tenant of the property. All these moneys are combined and allow the SMSF to make additional instalment payments on the super loan until the property is fully paid off. In that sense it works pretty much like a traditional principal and interest loan.
Whilst there is a SMSF loan the property is held in a separate entity called a property trust. The property trust is the legal owner and holds the investment property on trust until the final instalment is paid or the property is sold. Once the final payment is made the property trust can transfer the investment property to the beneficial owner, the SMSF.
Why would you invest in property through a SMSF?
Superannuation is the tax haven of Australia. All income in the SMSF is taxed at 15% only. Capital gains tax is 10% if the investment is held for more than 12 months or NIL if sold in pension phase. There is nothing outside of superannuation that can compete with this favourable environment. On the back of these parameters a superannuation strategy with property becomes one of the best investment options available to Australian’s today.
Yes, investments are locked up until retirement and you will have to wait until then. However, properties held in super have strong cash flow models because up to four members can pool their employer contributions into the one investment. In addition, you will gain full control and flexibility with regard to making your own investment choices.
No doubt, property investing in personal names outside of super is already a lucrative strategy. Doing the same inside super is like turbo charging your investment. SMSF loans are paid down much faster, there is almost no drag on returns from tax and the investment is leveraged to maximise future value.
How to get started?
A property warrant is an investment vehicle that requires careful planning. First, a super and property strategy together with a cash flow model are designed. Then the right property must be researched and a compliant property warrant structure must be set up.
This is a specialist area and a professional adviser like a financial planner at Equity Resource can assist you with the necessary expertise. Let us know if you'd like to check out your options.
Follow this link to read more details about property warrants.
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