Property Investing in SMSF

[MIW]

Hi

Just attended a seminar yesterday on investing in property using SMSF and an idea came to mind.

1. Buy an investment property using SMSF
2. Rental income + 9% contribution will be used to pay P&I of the loan (should be sufficient)
3. Sell the property after 5 to 10 years (assuming there is growth) and pay 15% CGT
4. Repeat step 1 to 3 again

Now, fast forward to 5 - 10 years before planned retirement age
1. Buy property that you intend to live in upon retirement and rent it out as an IP
2. Upon pension / retirement age, withdraw assets from SMSF (including the property) without trigger CGT or Stamp Duty and move in.

Is the above idea sensible and any pitfalls / disadvantage to this ?

Cheers

I think the contributions are changing to 12% now from 9%.
Buying property and reselling as Terry said would cost you in Stamp Duty, Agent's Fees and CGT.
I am not 100% sure but if the property is paid off I am sure that extra rental yield could be calculated towards a new loan to purchase a new IP.
My current 3 cash IPs in Super earn over $70K gross yield so surely the lender would look at your overall situation.
You may be aware that I am working on my SMSF strategy now and I just decided that with 30% deposit I have available I will borrow 70%. The rental buffer will permit me for contingencies and so will extra contributions.
In addition I could sell those 3 IPs and obtain further finance to buy more.
The only time I would sell would be to buy more premium property (by that I would adopt the monopoly strategy where I would sell the houses and buy a hotel).
First two things I need to finalise first is to calculate my borrowing capacity (finance) and check that the Trusts Deeds have been correctly set up (structure).
After May when I know I will keep you updated.
Yes, I agree many people with long term view over look SMSF for investing in property so good on you for being proactive (just have a look at the overall cost figure for setting up the structure if you have enough $$)!

 

[Rolf Latham]

No offset on a fixed rate

yes there is : )

its just not 100 %

In the non SMSF space CUA and ABL will do 100 % on fixed

ta
rolf

 

[Aaron_C]

The Dragon has an offset too with fixed rate - 0.70% offset

 

[euro73]

OK. stand corrected. They allow this for their SMSF loan?

Here's something a little unrelated... starting to become a bit of a focus for planner and property sales groups
http://nrassuper.com.au/

 

[Rolf Latham]

OK. stand corrected. They allow this for their SMSF loan?

Here's something a little unrelated... starting to become a bit of a focus for planner and property sales groups
http://nrassuper.com.au/

I have said for a while now the nature of financing NRAS means its generally a better strategy for SMSF than outside.

Simple reason.................NRAS in the middle term is going to be hard to leap frog from...........not easliy poss in SMSF so...........they can make a good marriage.

ta
rolf

 

[euro73]

Sure, but the counter argument is that the tax effectiveness is less. NRAS is less effective tax wise, on an annual basis inside SMSF, than it is outside SMSF. ( then again so is any property, to be fair) Thats because the significant annual deductions available on NRAS, through 20% lower rental income, depreciation etc only offer SMSF's a benefit at a marginal tax rate of 15% v 38.5% for most investors outside SMSF.

Offsetting that though, is the reduced CGT for properties purchased inside SMSF. Ive done some basic modelling on the comparisons (below FYI) and over 10 years they wash out about the same.

Working on a 400K property that attracts rent of 450 per week ( or 360 under NRAS) and assuming 250K growth over 10years, and an average interest rate of 7% Interest Only, and annual property costs of 5K ( management, rates, etc) here's how it washes out. Of course there can be variables to this. For example, Ive used the same rental income, interest rate and NRAS incentive for each of the 10 years- the rental income and NRAS incentive will increase over time, and the interest rates may change up or down, but it serves to demonstrate a conceptual outcome, at least.

NRAS outside SMSF - Annual Cash/Tax
Rental Income $18,720
Less Interest *$28,000 ( holding cost 1)
Less Costs *$5,000 ( holding cost 2)
Less Depreciation $10,000
Deductible Loss $24,280 @38.5% = $9347.80 ATO refund
Holding Costs - Income minus Costs = $14280
NRAS Incentive $9524
Cash Flow Position - +4591.80

NRAS outside SMSF - CGT
CGT Cost Base $400,000
Sales Proceeds $650,000
Assessable Gain $125,000 (50% x 250K)
CGT payable $48,125 (MTR 38.5% x 125K)

NRAS outside SMSF - 10 year final position
Cap Growth $250,000
CGT Payable $48,125
Net costs x 10years $ +45,918
Total after tax wealth created $247,793



NRAS SMSF - Annual Cash/Tax
Rental Income $18,720
Less Interest *$28,000 ( holding cost 1)
Less Costs *$5,000 ( holding cost 2)
Less Depreciation $10,000
Deductible Loss $24,280 @15% = $3642 ATO refund
Holding Costs - Income minus Costs = $14280
NRAS Incentive $9524
Cash Flow Position - -$1114

NRAS SMSF - CGT
CGT Cost Base $400,000
Sales Proceeds $650,000
Assessable Gain $0
CGT payable $0

NRAS SMSF - 10 year final position
Cap Growth $250,000
CGT Payable $0
Net costs x 10years $ -11,140
Total after tax wealth created $238,860



What doesnt appear in the modelling though, is how the surplus cash flow from NRAS can be used outside an SMSF to create additional wealth, by redirecting the surplus cashflow to paying down non deductible debt.

For example, if you were to look at a person with a 300K P & I loan, which also averaged 7% over the next 10 years, and they were to make additional repayments using the surplus NRAS cashflow of $4591.80 ( based on the NRAS model above) annually ( $382.65 per month) then they would save $161,741.52 in interest and 10 years/4 months off a 30 year mortgage.

This option isnt available to an SMSF, as surplus funds cant be redirected to an Owner Occupied debt. And thats why NRAS outside SMSF is more effective than inside SMSF.

Some more examples-

For a 350K loan @ 7% - savings are $172,631 and 9 years/5 months
For a 400K loan @ 7% - savings are $181,886 and 8 years/7 months
For a 450K loan @ 7% - savings are $189,854 and 8 years
For a 500K loan @ 7% - savings are $196,791 and 7 years/5 months

The accelerated repayment of non deductible debt which the surplus NRAS cash flow offers, is a powerful wealth creator, because it frees up borrowing power and equity to purchase additional investment properties that would likely have otherwise been out of reach, or at its most basic, it just allows you to realise significantly more CGT free profit when you sell your PPOR down the track, because you owe so much less to the bank, or just to be mortgage free on your PPOR far sooner. All good things.

So yeah, NRAS is certainly very attractive for an SMSF. But NRAS outside an SMSF is significantly more powerful. There's a double effect of Cap Growth plus massive savings on a PPOR mortgage. The moral? buy one for yourself and one for your SMSF and take maximum advantage of the cash flow from NRAS to dramatically improve your position over 10 years

 

[Paul Thewlis]

The decision of NRAS inside or outside SMSF is not really the question in most cases. The SMSF is a separate entity with a separate financial position. The decision is more between NRAS and non-NRAS properties once you have decided direct property investment is part of your investment strategy.

Our modelling shows that NRAS can work really well inside a SMSF but there is a balancing act required. You need to balance the amount of SMSF funds used for property, the level of gearing and the tax deduction treatment to obtain a positive cashflow position and a neutral tax position. On the later you don't want to get enough negative gearing to balance against tax on contributions and income on other assets in the fund but not too much that you have tax losses accumulating in the fund.

With NRAS you get a nice mix of tax benefits without it being an on-going drain on the SMSF asset position that might be the case with negatively cashflowed property.

 

[euro73]

This is all very true Paul. Two separate "entities " ( an individual/couple/trust and an SMSF) are different beasts and each of the entities needs to determine its investment appetite, and whether resi property is part of that appetite.
Assuming for the moment that it is though, too may commentators seem to unfortunately believe properties eligible for the NRAS are best ONLY purchased by an SMSF, and thats the best way to employ the scheme's cashflow advantages.
My view is that like you, I believe that all things being equal; yes, NRAS is a superior strategy for SMSF when compared with non NRAS for an SMSF, but NRAS outside SMSF is a more effective investment strategy.
RE SMSF- because the scheme's cash flow advantages allow the SMSF to hold the property and accumulate growth over a prolonged period with little or no holding costs/contributions required from the fund itself, outside of the initial deposit and first years holding costs- its immediately attractive. A no brainer, really. But not all SMSF's have the capacity to purchase resi investment property, because a 30% deposit will generally be required ( 20% in some cases) and borrowing capacity may not be what they think it is, especially when the reduced rental income required by NRAS is factored in. There's also the issue of liquidity ( holding costs need to be paid in the first year before the NRAS incentives kick in) , diversification etc.
Certainly though- for those SMSF's looking to invest in property and who can make the numbers work, NRAS is very smart and very attractive. Potentially ( well, incredibly likely to be fair) far more attractive than non NRAS, as my modelling ( and yours, I assume) demonstrates pretty clearly. Because of LVR and borrowing capacity constraints though, tends to be easier if purchasing the less expensive NRAS properties.

But more widely, NRAS clearly offers significantly greater benefits outside Super. Not only are the annual cash flow benefits superior, the deductions applied to a higher marginal tax rate and the LVR and borrowing capacity issues far less restrictive, but the bottom line is simply that the surplus funds generated can be redirected towards non deductible debt and save years of interest, creating more equity, faster, and therefore allowing additional investment far sooner, or just to become non deductible debt free, faster. It's a compounding effect and its incredibly powerful.
Keep in mind that the modelling Ive done previously is ultra conservative, and represents worst case, not best case. I say this because Ive factored in no increase to the incentives, which we know will increase to $9981 for 2013 and annual thereafter. (I worked on 10 years x $9524) so I'm not showing anywhere near the maximum potential surplus being redirected towards paying off the mortgage over 10 years. I'm showing the absolute minimum, and am actually understating it by quite a distance. Ive also divided the annual surplus into twelve, and calculated the interest savings on the non deductible debt based on monthly additional repayments equal to 1/12 of the annual surplus cash, rather than calculating the savings based on one larger annual lump sum principle reduction. So the benefits Ive estimated in my modelling are by any measure extremely conservative.
Anyway, as Ive said in my modelling- effectively the same after tax net profit on the NRAS property whether purchased inside or outside Super, but outside super the investor also sees the additional benefits of several hundred thousand in interest savings and at least a decade removed from their mortgage schedule.
So I would still argue that NRAS should ideally first be purchased outside Super, and if the SMSF can also afford to, it should also seek to purchase an NRAS property inside its structure. But you're right - its not a case of one or the other. They're two different entities and should devise strategies separately. Thats why I said the ideal is to buy one in each