Lately, I have been asked multiple times about the name to go on the contract of sale when buying a property under SMSF and the costs involved. I wrote this article to shed light on different aspects of SMSF.
The structure and legal framework surrounding SMSF property investment can be complex. In this article, I will explain how property investment works within an SMSF, including ownership structure, loans, and ongoing costs, empowering you with the knowledge to make informed decisions.
SMSF Structure: Who Owns the Property?
When investing in property through your SMSF, the ownership of the property doesn’t sit directly under the SMSF but under a separate entity called a bare trust (or custodian trust). This structure exists because of the strict rules surrounding borrowing within an SMSF, particularly under the Limited Recourse Borrowing Arrangements (LRBA).
Here’s how it works:
- SMSF: Your SMSF is the ultimate beneficial owner of the property. Any rental income, tax benefits, and capital gains from the property accrue to the SMSF.
- Bare Trust: The legal title of the property must be held in the name of a bare trust (also called a custodian). The trustee entity is created solely to hold the property on behalf of the SMSF, but it has no rights to the property benefits.
The SMSF is the beneficial owner, while the Bare Trustee holds legal ownership only as a formality to comply with the borrowing rules.
So, once the structure is setup with Corporate Trustee, you should have four different entities –
- Bare Trust
- Corporate Trustee for Bare Trust
- SMSF Trust
- Corporate Trustee for SMSF Trust
On the contract of sale, the name should appear as below –
Corporate Trustee for Bare Trust as Trustee for Bare Trust
Loans: Whose Name Should the Loan Be Under?
When borrowing to purchase a property through your SMSF, the loan must be in the name of the SMSF trustee. However, this loan structure comes with some critical considerations:
- Limited Recourse Borrowing Arrangement (LRBA): Any loan for property investment within an SMSF must be structured as an LRBA. This type of loan limits the lender’s recourse only to the property being purchased. In other words, if the SMSF defaults on the loan, the lender can only claim the property, not the other assets in your SMSF.
- Loan Application: The loan is taken out in the name of the SMSF trustee, but the bare Trustee holds the property. The lender will assess the loan based on the SMSF’s ability to service the debt. It’s important to note that if the SMSF defaults on the loan, the lender can only claim the property, not the other assets in your SMSF.
Ongoing Costs of Property Investment in an SMSF
While SMSF property investment offers several advantages, knowing the ongoing costs is essential. These can add up and affect the overall returns of your SMSF:
- Loan Repayments: The SMSF must make regular loan repayments, including the principal and interest. These payments are typically funded through rental income or regular and personal contributions to the SMSF.
- Property Management Costs: If you rent out the property, you’ll likely need to pay for property management services. These costs can vary.
- Repairs and Maintenance: As the SMSF holds the property, it is responsible for repair and maintenance costs. The SMSF’s funds must cover these expenses.
- Insurance: Your SMSF must insure the property, including landlord insurance, if it is a rental property.
- Council Rates and Taxes: Ongoing council rates, water rates, and land taxes must be paid from the SMSF’s balance.
- SMSF Compliance and Reporting Costs: Managing an SMSF comes with administration and compliance requirements. These include annual audits, tax returns, and financial statements, which qualified professionals must complete. These costs can range from $2,000 to $4,000 annually.
Potential Benefits of Property Investment via SMSF
While the structure and costs may seem daunting, investing in property through your SMSF offers several potential benefits:
- Tax Efficiency: Capital gains on properties held for more than 12 months are taxed at a discounted rate of 10%. Once you reach the pension phase, the income and capital gains could be tax-free.
- Diversification: Adding property to your SMSF portfolio allows diversification away from traditional assets like shares and bonds.
- Wealth Building for Retirement: Over the long term, property investments can provide stable income and potential capital growth, enhancing retirement savings.
