The ability to use an SMSF to take out a limited recourse loan to buy property has been allowed to continue despite a recent inquiry recommending it be banned. This was viewed as a legitimate financing option as there is currently no evidence that debt levels inside the super system posed a risk. So lets explore this further now we know it is here to stay for the time being.
What is limited recourse borrowing?
Limited recourse borrowing inside an SMSF means a fund can borrow from a bank to buy a property and the bank will only be able to hold the property as security. In the case of a default, the lending bank will have no recourse against other assets in the SMSF or its members.
What do the banks offer?
The limited recourse nature of the loans means that banks will typically only lend up to 60-70% of the property. The rates are also not as competitive and will be higher than a typical investment loan, so shopping around is important and factoring this into the investment case is essential.
Is this a good strategy?
It really depends on your individual circumstances and the type of property being considered. There are real benefits to buying and holding a good property in a low tax environment for retirement. It means superannuation guarantee contributions, salary sacrifice and rent all being being taxed at a concessional 15% rate go towards paying off the property. The law also currently allows for a property to be sold capital gains tax free in retirement or pension phase.
Commercial property has long been a popular investment inside an SMSF. Typically this will be a business owner buying the premises in which their business operates. It means security of tenancy for the business and the rent goes to paying down the property that will ultimately fund the retirement of the business owner.
It’s not surprising that residential property has also increased in popularity over recent years. As for any decision to buy property a degree of caution should be applied. It’s an area where property marketers selling expensive new developments with poor long term capital growth prospects have tended to operate. This is going to be an area we are seeing people get into trouble because they have not had independent advice.
What are the limitations?
You are not able to personally use a residential property held by your SMSF. That means buying a holiday home or renting it out to related parties such as your children is not permitted. It is also not possible to transfer a residential property you already own into your SMSF, but this can be done for commercial property.
Negative gearing inside super is not as beneficial given the lower tax rate. That said, we would question the rationale for buying a loss making property in any structure at this stage of the cycle where capital growth over the next few years is likely to be limited.
This is a complex area and getting independent advice as to the appropriateness of the strategy and setting up the structures is essential.
Rob Gilmour is the Managing Principal of Wealth Simplicity. The information provided should not be considered personal financial advice as it is intended to provide general advice only. The content has been prepared without taking into account your personal objectives, financial situations or needs. You should seek personal financial advice before making any financial or investment decisions.