Buying property with self-managed super: a few things you should know PROPERTY LADDER: Consider options on super fund management as you prepare for retirement. Source: Sunday Herald Sun BUYING property through self managed super funds (SMSFs) seems to be flavour of the month, but while friends and relatives may be waxing lyrical about the benefits, theres a lot to understand before jumping on the bandwagon. What's all the hoopla about? Last year the Australian Taxation Office clarified what is allowed and what isn't when it comes to borrowing money to buy and maintain property with a SMSF. People have always been able to buy property via SMSFs but what has changed in the past few years is that SMSFs can now borrow money to do so. This has meant that SMSFs are now able to make investments that they may not previously have been able to afford. Prior to 2007, funds could not borrow to invest and even after the super rules were updated to allow it, there existed some doubt about other things like whether a fund could make improvements to property. Here's the rules There are strict rules governing what money borrowed through an SMSF can be used for. For example, spending borrowed money on repairs and maintenance is ok, but spending borrowed money on anything deemed to be an "improvement" is not allowed. While improvements to the investment property are allowed, they must be funded using other money in the SMSF (such as money from member contributions) and not any funds the SMSF has borrowed. The net result of having clearer guidance from the ATO is that today it is far easier for funds to borrow money to invest and with the advantages this strategy seemingly offers its popularity has soared. What are the benefits? Some of the potential benefits of buying property through a SMSF include the fact that the fund will pay a maximum 15 per cent tax on rent from the property. On properties held for longer than 12 months, the fund also gets a one third discount on any capital gain it makes upon sale. The remaining two thirds are then added to the fund's income and taxed at the funds rate of 15 per cent, effectively providing a ten per cent tax rate. Also, once fund members start receiving a pension at retirement - assuming they've held onto the property this long - they'll pay no tax on either rental income or any capital gains tax when they sell. Investing in property this way also puts people in control of how one of their biggest assets, superannuation, is invested. It's little wonder that it has become a very attractive and popular way to save for retirement. But, like anything in life, people need to go into the arrangement with their eyes wide open. For example, depending on whether a person would be making a taxable loss or gain with an investment property, and factoring in what their marginal tax rate is, they may be better off holding a property investment outside of super. It all comes back to looking at what's best for the individual and their circumstances. With something as important as the money a person hopes to retire with, it's worthwhile researching any retirement strategy thoroughly and seeking independent advice before deciding if it's the right choice for you. Who is it right for? Buying property using a SMSF has some big ticks but one of the key's to a healthy investment strategy is diversification, so it makes sense for people who have sufficient funds within super to maintain a diversified portfolio - or at the very least have a plan to build diversity into their portfolio over time. This investment strategy may also be suited to people who can afford to make sufficient contributions within super to fund the loan and maintenance costs - and those who have the time and knowledge (or who have extremely well-qualified advisors in place) to run the SMSF. But don't even think about buying a property through a SMSF and using it "on the quiet" as a free or discounted holiday home. No members of the fund can stay at the investment property, even if they pay market value rent. The penalties are high and not worth the risk. Purchasing property through a SMSF can be advantageous for business owners because the rules allow people to operate their business out of the property purchased by their SMSF. Don't count on operating rent free or at a discount though - rent must be paid and it must be commensurate with what would be charged to any other prospective tenant. Who is it not right for? Purchasing property via a SMSF may not be advisable for people who lack sufficient levels of super contributions to adequately fund it - that is, low income earners or people who are going to really stretch themselves financially in terms of cash flow. It may also not be appropriate for people whose investments are not diversified and who have no plan to build diversity into their portfolio in the future. Putting all super eggs into the one property basket - rather than spreading a portfolio across other types of investment - can be a potentially risky strategy. It may also make it difficult for SMSF trustees to maintain appropriate levels of liquidity (the ability to sell an asset easily to gain access to money) in the fund. It can be easy to underestimate the costs in terms of time and money it takes to successfully manage a SMSF, so it's important to do your homework and seek advice from experts. Keep in mind that the Australian Taxation Office can impose harsh penalties for those who do not comply with the rigorous auditing and reporting requirements for a SMSF and some people find themselves unwittingly breaking the rules because they do not fully understand the requirements. The complexity of SMSFs cannot be understated - it's vital not only to get tax, legal and financial advice, but also to make sure that your advisers are up-to-date in this area. Get the documentation wrong for the borrowing arrangements, for example, and you could end up paying double the stamp duty on an investment property. It really does pay to choose your advisers wisely and remember that ignoring the fine print is at your peril! It's worth knowing that you can get in-house administration support with certain SMSF products - this can save time, money and heart-ache in the long run. Things to weigh up If buying property within a SMSF is something you are seriously considering, here are a few things to weigh up. As a general rule, it's a good idea to have a SMSF in place before looking at investment properties. The process of setting up an SMSF can be lengthy , so all the time and effort put into finding the property investment of your dreams could go to waste if your ducks aren't in a row by settlement time. It's important to do your research. The Australian Securities and Investment Commission (ASIC) website at www.asic.gov.au - is a good place to start. Then speak to your advisers about whether this strategy would suit your personal goals, timeframe and feelings about risk. People must be aware of the costs associated with managing the SMSF (quite aside from the establishment costs if you don't have an SMSF in place already) and adding a borrowing arrangement into it. People venturing into this territory also need to be sure to have plans and an agreement in place for what all members of the fund would want to happen following the death or permanent injury of a key contributing member. Investing in property through a SMSF can be a powerful way to build your superannuation, ensuring you will be able to live the life you want in retirement, but it's important to be clear about your obligations and have the time, money and ability to meet them. Claire Esmond of Pave Wealth Services (WA) is an Authorised Representative of AMP Financial Planning Pty Ltd, ABN 89 051 208 327, AFS Licence No. Any advice given is general only and has not taken into account your objectives, financial situation or needs. Because of this, before acting on any advice, you should consult a financial planner to consider how appropriate the advice is to your objectives, financial situation and needs.