Purchasing real estate by an SMSF and the implications from an Estate Planning perspective.
Self-managed superannuation funds (“SMSF”) are becoming a common vehicle to invest in real estate particularly for residential real estate. The income of an SMSF is taxed at the rate of 15% however any income derived by the SMSF whereby it qualifies to be in pension phase is exempt from income tax altogether.
In addition to income tax benefits, there are also capital gains tax benefits in using an SMSF to purchase real estate whereby capital gains tax is at a maximum rate of 15% and once the SMSF reaches the pension phase, there will be no capital gains tax payable.
There are therefore compelling reasons to consider using an SMSF for the purchase of real estate but the advantages and disadvantages must be carefully considered.
To purchase real estate in a SMSF, the SMSF either has to have all the funds available for the purchase price, or if it wishes to borrow funds, there are very strict guidelines for such borrowings. These must be considered before a Contract of Sale & Vendor’s Statement is signed.
Borrowing by an SMSF requires that the real estate is purchased by a separate entity and such entity must enter into an agreement to hold the property as bare trustee for the SMSF. It is the separate entity that borrows for the purpose of purchasing the real estate. It is a specific requirement that the security for the borrowing is to be limited to the single asset being acquired and that no other assets of the SMSF can be placed at risk (this is called a limited-recourse loan). The bank may also require a personal guarantee to be provided. The loan is different to the usual loan that a bank will provide.
It is important to note that once the SMSF has purchased the property, it cannot change the nature of the property and cannot borrow further funds for this purpose. In addition, if an SMSF purchases residential real estate, such property cannot be lived in by a member of the family. It is also important to be aware of what the SMSF can do so that there are no breaches. Any breaches may results in the SMSF becoming non compliant and its assets being taxed at a much higher rate (up to 46.5%).
One must also be aware that there are additional expenses in establishing the SMSF and the structure for the purpose of borrowing. These should also be considered before proceeding to purchase.
From an estate planning perspective, the advantages are similar to any other asset acquired by the SMSF and dealt with in accordance with the appropriate regulations and the provisions of the trust deed.
It is important to note that assets which form part of an SMSF are not dealt with by your Will and that any assets in the SMSF must be specifically dealt with in accordance with the appropriate legislation and the provisions of the trust deed governing the distribution of any assets of the SMSF.
It is common to prepare a binding death nomination in respect to such distribution and this must be carefully considered at the same time that the Will is made taking into account any trusts or entities which are owned or controlled by the Will maker. The nomination will usually nominate a specific person or entity who will be entitled to the assets of the superannuation fund. This all forms part of estate planning discussions.
For more information please contact Felicity Simpson or a member of our Commercial Law Team.
