Can you invest in property with an SMSF
You can invest in property though an SMSF on the basis the investment strategy for the Fund allows for property investment. The investment strategy should align with superannuation laws and the Trustee objectives. Investing in property through an SMSF must be bought solely to provide retirement benefits. It needs to align with what the SMSF has set out to achieve in terms of growth, income, risk and diversification. Property has become a popular investment choice for SMSF’s because it is seen as a long-term tangible asset that can provide rental income as well as potential capital growth overtime. One of the main reason Trustees would use Super to invest in property is there is generally free cash or funds available to invest compared to your personal situation.
SMSF property investment rules
Sole purpose test
The sole purpose test means that property must be bought and held only to provide retirement benefits for the Members. You cannot live in it, holiday in it or let any family members use it. All
aspects of the investment have to point to long-term retirement outcomes and not be seen as deriving a short term personal benefit.
Arms-length requirements
Arm-length rules are to make sure everything is complete on normal commercial terms. This means that the property must be bought at market value, rented at market rates and managed like any other investment. You are unable to give yourself or related parties special deals such as discounts or favours.
In-house asset rules
In-house asset rules limit how much an SMSF can invest in assets that are related to its Members. The cap is at 5% of the Fund’s total value. For property, it usually means that residential property can’t be bought from a Member or rented to them. The rules for commercial property is more lenient in that it can be purchased from a related party and be leased to your own business.
Compliance Importance
Making sure that your Fund is aligning with the superannuation laws before buying a property is crucial. This is because there are serious consequences of non-compliance such as heavy fines, extra tax, or even the SMSF losing its compliance status. By making sure that your Fund is complying before buying a property and on an ongoing basis, it will protect both the Fund’s ongoing compliance status.
Types of property SMSF’s can invest in
Residential Property
Residential property may be suitable for Trustees that like the idea of owning a tangible asset that can generate regular rental income whilst offering long-term potential capital growth. Residential property can suit SMSF’s when the Fund has sufficient cash flow to manage the ongoing expenses such as maintenance, insurance, property management fees and periods of vacancy. The rules around residential property investment for an SMSF are very strict. Members and their relatives cannot live or use the property in any way. It must be rented out to unrelated parties at market rates. A residential property has some downsides, for example it can create liquidity challenges, as it is not as easy to sell quickly if the Fund needs cash to pay for any expenses. Another downside factor is diversification risk, especially if a large portion of the SMSF’s balance is invested in a single property. Trustees need to asses affordability, diversification and long-term sustainability before committing to a residential property investment. Lenders may require a financial advisor or accountant signoff to ensure Trustees understand their responsibilities before issuing a loan. We can issue account letter for the funds we administer.
Commercial
Commercial property allows for greater flexibility as compared to residential property investment. This is because one of its biggest advantages is that it allows for Trustees to lease the property to a
related party, for example it can be leased to a Member’s business. This is provided that the arrangement is on an arms-length terms and reflects the current market conditions. This can provide stable rental income for the SMSF as the asset is kept in the family structure. Commercial leases are generally longer than residential leases and may even include clauses where the tenant pays outgoings such as maintenance and insurance, improving the cash flow of the SMSF. On the downside, commercial property often require a higher initial investment deposit as well as can be more difficult to sell. Vacancies can last longer and the property values may fluctuate more depending on the location and business demand.
Overseas
Overseas property investment through an SMSF can offer diversification benefits as the investment spreads across different property markets and economies. This may help reduce the reliance on the Australian property market and provide opportunities to invest in countries with strong economic development. Also, some Trustees are attracted to overseas property due to lower purchase prices or higher rental yields. When investing in overseas property, the SMSF must still comply with the Australian superannuation laws, as well as meeting the legal, tax, and regulatory requirements of the overseas country. Exchange rates is also another major factor, as fluctuations can impact both income and capital value. The management of the overseas property can be challenging because of the distance, time zones and the reliance on foreign agents, which can increase costs and reduce control. Another key factor is that other countries don’t recognise or understand what a SMSF consists of, therefore making the investment process more complicated than investing in Australian properties.
Borrowing to buy property in SMSF
Legislative compliance
Under the SIS act, section 67 prohibits SMSF’s from borrowing. The idea behind this rule is to protect retirement savings by limiting risk and leverage inside superannuation. Without this restriction, Funds could take on too much debt and put Members’ retirement benefits at risk.
How to bypass section 67
While section 67 restricts SMSF’s from borrowing money, the law allows an exception using a structure known as a Bare Trust. Through a Bare Trust, the property is held in a separate Trust on behalf of the SMSF until the loan is fully repaid. The SMSF gets the benefits of the property, such as rental income and capital growth, but doesn’t legally own it outright. This structure allows the SMSF to borrow without breaching section 67.
Limited recourse borrowing
Borrowing in an SMSF must be done through a limited recourse borrowing arrangement, or LRBA. This means if the SMSF can’t repay the loan, the lender’s rights are limited to the property itself, not the other assets in the Fund. This helps protect the rest of the SMSF’s investments and keeps risk contained. Be mindful bank would generally ask Trustees to guarantee the loans issued in a personal capacity.
Related Party Loans
Explanation on related party loans
Related party loans are attractive to SMSF’s who cannot access bank lending or would like more flexibility around borrowing. Instead of borrowing from a bank or traditional lender, the SMSF borrows from someone that is connected to the Fund. This includes a Member or related entity of the Fund. While this can make property investment more accessible, it comes with extra responsibilities. The loan must still be properly documented, supported by a formal loan agreement, and managed similarly to a bank loan. If it isn’t structured or maintained correctly, the ATO may view it as non-compliant, which can lead to tax and regulatory consequences.
ATO Safe harbour requirements
When an SMSF borrows from a related party, like a Member or a family trust, the ATO expects the loan to be set up under commercial terms. These are known as the safe harbour requirements and designed to make sure the SMSF isn’t getting a special deal that could breach the arms-length rules. The Safe Harbour terms are listed here:
- Applicable interest rate for each year of the LBRA should be used; the ATO updates these rates annually using RBA rates as a base
- The maximum loan term is 15 years
- The maximum LVR is 70%
- A registered mortgage over the property is required
- Each repayment comprise of both principal and interest, and the repayment is required to be paid monthly
- A written and executed loan agreement is required.
SMSF Compliance obligations for property owners
Ongoing Trustee responsibilities
Owning a property through an SMSF comes with responsibilities for Trustees. Trustees need to actively manage it in line with the Fund’s investment strategy. This includes making sure the property is maintained, rent is collected at market rates, expenses are documented and the investment continues to serve the purpose of providing retirement benefits.
Valuations, audits and reporting
SMSF’s must complete valuations, audits and reporting on an annual basis to stay compliant. Property valuations are required at least annually to determine the Fund’s value for Member statements and to calculate any tax obligations. Audits can assist with the Fund staying complaint with the superannuation laws, including correct record-keeping and investment rules. Trustees also need to lodge annual returns with the ATO and report income and capital gains, which Superannuation Warehouse can provide assistance with. Keeping on top of these requirements will help avoid penalties an maintain the Fund’s complying status.
Penalties
Failing to meet SMSF compliance obligations can result in penalties. The ATO can impose fines, extra tax, or even disqualify Trustees in severe cases. Non-compliance can also threaten the Fund’s status as a complying SMSF, which could mean all the Fund’s assets are taxed at higher rates, reducing retirement savings. For property-owning SMSFs, even small breaches, like undercharging rent or not updating valuations, can have consequences.
Depreciation
Reduces taxable income of the SMSF
Depreciation is a tool for SMSF’s that own property as it can reduce the Fund’s taxable income. The Fund can claim a deduction for the decline in value, like the building itself and for equipment inside the property. This deduction lowers the Fund’s assessable income, reducing the amount of tax the SMSF has to pay each financial year. For SMSF’s in the accumulation phase, this can make a difference to the Fund’s cash flow, helping it grow more efficiently overtime. Best is to use a quantity surveyor to maximise the depreciation allowances.
Accumilation phase
The benefits of depreciation are more suited and prominent during the accumulation phase because the SMSF is still paying tax on its income, at a rate of 15%. Whereas in the pension phase an the SMSF’s income has a 0% tax rate. By claiming depreciation, the Fund can offset some of this tax and keep more money invested for growth. However, once the SMSF moves to its pension phase, and has a 0% tax rate on income. The tax deduction no longer reduces tax, there is still a deduction however there is no tax benefit.
Benefits of investing in property with an SMSF
Long-term capital growth
Property values tend to increase overtime, and owning a property can increase the Fund’s overall balance. The growth contributes directly to the Members’ retirement savings, helping the SMSF meet its long-term objectives.
Tax advantages
Investing in property through an SMSF comes with some attractive tax benefits. While the Fund is in the accumulation phase, rental income is taxed at a concessional rate of 15%, and deductions like depreciation reduce taxable income. Once the Fund moves into the pension phase, income from the property, including rent and capital gains, is generally tax-free. This combination of concessional taxation and tax-free income in retirement makes property a very efficient investment vehicle for boosting retirement savings over the long term.
Control and investment strategy alignment
Unlike Retail or Industry Funds, where investment decisions are largely made for you. Trustees can choose specific property, location, and type of investment that aligned with
their Fund’s investment strategy. This allows Trustees to match their portfolio with their risk profile, income needs and long-term retirement goals.
What happens when the property is paid off
When the LRBA is paid off the legal title of the property will revert to the SMSF. There is generally no stamp duty payable on this transfer as there’s no change in beneficial ownership, but please double check this with your conveyancer.
Also, once Trustees meet a condition of release the property can be sold at market rates to the Members. This may be a good strategy to purchase a property at today’s prices if you want to secure your retirement residence.
Risks and considerations before investing
Liquidity and diversification risks
Remember property is an illiquid asset and may need time for settlement if Trustees need access to funds. If a large portion of the Fund’s balance is invested into the one property, it can create pressure to cover expenses as well as diversification risks.
Cash flow and holding costs
Owning property comes with ongoing costs like maintenance, insurance, council rates, property management fees and loan repayments if the SMSF has borrowings. Rental income may not always be able to cover these costs, especially if there are periods of vacancy or unexpected expenses.
Exit strategy and retirement planning impacts
Selling a property can take time, and market conditions can affect the timing and value of the sale. Trustees need to consider how and when they might liquidate the property to fund retirement benefits, especially Members are approaching or already in the pension phase. Without a clear exit strategy, there’s a risk that the property could limit flexibility and affect the Fund’s ability to meet its Members’ retirement goals.
Next steps
Although Trustees may obtain financial advice to purchase a property, this is not a legal requirement. Trustees are ultimately responsible for the investment choices in their SMSF.
If you want to purchase property in super, make sure you can do at least a 20% deposit for residential property and 30% for commercial property as this is what most lenders require. In addition, the Fund will generally need around $50,000 in free cash to cover contingencies and this is what most lenders will require.
Lastly, an SMSF can be a good choice even if you don’t have enough to purchase a property now. You can use the SMSF as a saving vehicle until enough funds are available and you then have time to find a property suitable for your long term retirement benefit.