Dear Bill and every body else ....
I note that Bill has purchased his first property with his SMSF using the borrowing structure and some others are planning to get into that situation and looking for information. There is a 11 page word document on the below webpage – which demystifies SMSF borrowing rules – click below
http://www.trustdeed.com.au/tools_pct.asp?action=1&link=tools&page=pct
Strategies of SMSF borrowing
Buying in the name of the SMSF has many advantages and I noticed that some of them have been highlighted by others. The good news is that you aware of only half of the fun which is
1) SMSF can borrow
2) Salary Sacrifice can pay off the loan
3) Your SMSF can invest in IP
The other half of the fun is below
1) SMSF can pay no tax on rental income;
2) When you sell the property - SMSF can pay no Capital Gain Tax;
3) When you retire - you can retire (live) in this property.
Let me explain each one of them below
1) Tax Free Income
A SMSF has two lives, 1st is the accumulation phase and the 2nd is pension phase - pensions or income streams can be commenced from a SMSF for members who have reached their preservation age - those born before 1960 it is 55 years. One point to note here is that superannuation interest paying a pension do not pay any tax - hence when you turn 55 (even working - transition to retirement pension) you must convert your fund to pension phase - then all the income / rent will not pay any tax.
How to covert accumulation account to pension account read below
http://www.trustdeed.com.au/tools_commence.asp?action=1&link=tools&page=commence
If you are in pension phase, any interest paid is also not tax deductible as you are not generating assessable income, hence purchasing property with borrowing, if you are already in pension phase does not make much sense.
2) Pay No CGT
As above, when the fund moves to pension phase - you can sell the property (even to yourself) - the sale will be recorded by the SMSF and NO TAX will be paid by the fund. If you sell the asset whilst the fund is in "borrowing phase" - the lender will be paid out first, the amount owed, the balance will then be returned to the SMSF.
The above two issues will make you wonder - why bother with buying property out of super - that's right folks! Investors who purchase property out of super will pay CGT if they sell their property and if they decide not to sell while they are alive - the kids (or grandkids) will pay CGT when the property is sold as the kids acquire the cost base of property on death.
3) Retire in the property
Most of us live in homes with families - once they grow up - we do not need that extra space and we "downsize" or take that "sea change" which we were waiting for our retirement years.
Well, with your SMSF borrowing this is possible. What you need to do is decide where you would like to retire, say gold coast, buy the property now with borrowing and use salary sacrifice to pay the property off - remember you cannot live in a residential property owned by the SMSF (Sole Purpose test) - but once you are ready, the SMSF can then sell the property to you at Market Value - I am assuming that you will be in pension phase and the SMSF will not pay any tax on the sale.
If you do not have the money to purchase the property - say it is worth $2M in 20 years time - then you can use the bank to borrow the money for one minute - the way it works is that the bank will give you the money in your bank account - from your bank account it goes in SMSF bank account for the purchase price - since you are on pension - you can make a 100% withdrawal as an account based pension - then the money comes back into your bank account with which you can return to the bank - all that happens in a minute - the money travels into your bank account from the bank then to the SMSF then back to your account and then back to the bank.
The SMSF cannot pay the property "In specie" as a pension to you - as only cash can be paid as a pension - for "In specie" the fund has to be accumulation phase - which means at the time of transfer - the fund will have to pay CGT. The above method is the only way it can be done. Further, now the property will be PPR, kids can get the property without paying any CGT on sale.
Other Strategies
The above are only some of the strategies available, there are many other strategies.
Common mistake in a bare trust transaction
After helping over 200 accountants and their clients in setting up these structures, one mistake which is usually made by purchasers is that they have already exchanged the contract with the wrong party, sometimes it is with the trustee of the SMSF and sometimes in the name of the members (if the idea was to purchase the property outside of super) – this mistake was done by Bill as well where he created the Bare trust after the purchase two days after the purchase date.
In my opinion, the bare trust should be created on the date of the exchange of contract (which is your purchase date). Sometimes it is not impossible to achieve this, since the trustee of the bare trust is not created (a company) and by the time you have already exchanged.
The solution to this problem is very simple, all you have to do is rescind the old contract, create the company and exchange correctly with the “trustee of the bare trust”.
Manoj Abichandani
SMSF Specialist Advisor
SMSF Specialist Auditor
B. Bus (UTS) PNA FTIA LREA SSA SSAud