As this is my first article in quite a few months, I thought it would be appropriate to provide a brief update on a handful of common issues on SMSFs that borrow to purchase property and other assets.

Items I am covering include:

• ATO warning on dodgy promoters & inappropriate structures
• Common mistakes made
• Property improvements – what you can and can’t do
• Purchasing property off the plan – things to watch out for
• Using borrowings to purchase listed shares

ATO Warning on Dodgy Promoters

When the ATO issues an alert on something, you know it must be fairly prevalent in the market – I mean they do their best but they don’t have the resources of the CIA.

Late last year the ATO issues a taxpayer alert (TA 2012/7) which highlighted some of the scenarios that have been reported to them and are being promoted as ‘legit  arrangements’ (which they definite are not!):

• Using money from a SMSF to help fund the purchase of a property that is not held in a holding trust on behalf of the SMSF – i.e. the title is held in the name of the individuals or another related entity.  This is definitely NOT allowable.
• You know that overpriced residential rental property you were sold a few years ago that has dropped in value?  You can set up a SMSF and use your super money to buy it off you!  Again – definitely NOT OK – your SMSF cannot buy residential property that you own personally (it can only buy commercial property).
• Yes – of course you will be able to get a loan to build a house on this block of land your SMSF just bought!  No. No you will not.  More on this further on.
• There are so many limitations and restrictions on SMSF limited recourse loan arrangements – we have a special unit trust we can set up to get around those silly rules.  I doubt it.

When it comes to combing your super with borrowings, it is a bit like the Wild West out there at the moment.  We have unlicensed property spruikers and marketeers trying to earn their commission by flogging poor quality, overpriced properties to unsuspecting battlers.

So how do you ensure you are not being stitched up?  Easy – you already are doing something about it by reading this article.  The other very important thing you need to do is to seek independent advice – which means someone totally unrelated from whoever is trying to sell you the property.

Common Mistakes Made

I am often asked for help from investors and advisers when people run into problems trying to purchase property via a SMSF limited recourse borrowing arrangement.  The most common mistakes made by people are:

• Contract in the wrong name
• Contract in the wrong name
• Contract in the wrong name
• Incorrect or cheap and nasty SMSF or holding trust deeds
• Trying to borrow too much

An essential element of a SMSF borrowing arrangement is that the title / legal ownership of the asset (whether it be property, shares or some other investment) must be held by a custodian or holding trust – not the SMSF itself.

This means when it comes to property, you need to have a company set up (this company will act as trustee of the holding trust) prior to signing any contracts.  The correct name on the contract should be for example:

XYZ Holdings Pty Ltd ACN 123 XXX 789 as trustee for The Bare Trust on behalf of ABC Super Fund

Alternatively, ‘XYZ Holdings Pty Ltd’ may be OK in some states provided all the holding trust documentation is correctly prepared (these document bring all the parties together).   Please note the ‘XYZ Holdings Pty Ltd’  in my example above is NOT the trustee company for the SMSF – it is a completely different company. Also, in some states the holding trust documents need to be executed prior to the contract being signed, while in other states, they should be dated after.

Another common mistake is trying to enter into a borrowing arrangement using a SMSF trust deed that is poorly drafted or doesn’t enable the SMSF to borrow under limited recourse loan rules as it is too old.  This is easily fixed by getting the deed amended prior to signing any contracts.

The next biggest reason a SMSF borrowing will fall over before it begins is simple – the loan serviceability doesn’t stack up – i.e. you are trying to borrow too much.  Before signing anything, you should have undertaken some analysis yourself, and also ran the numbers by either a financial planner or mortgage broker to assess the borrowing capacity of the SMSF.

A good rule of thumb I use is that you need 35% – 40% of the purchase price to ensure the loan will be approved and the investment will be cash flow positive from day one.  Just because you can borrow up to 80% (for residential property) from most lenders, doesn’t mean you should.

Property Improvements

The ATO has clarified its position on property improvements and renovations that can be undertaken to property held under a SMSF borrowing arrangement.  In general, you can use existing cash the SMSF has to improve a property, provided those improvements don’t fundamentally change the underlying character of the property, or impact the title in any way.  This means you cannot sub-divide and you can’t convert a residential property to a commercial property and vice-versa.  You also cannot borrow money (even from a related party) to fund any improvements.

Buying off the plan

Buying off the plan can be risky due to the time between making the commitment to buy, and when the deal needs to be settled – especially because typically the contact will be unconditional.  This presents a problem if the final valuation done by the lender comes in a lot lower than the contract price – the purchaser – i.e. the SMSF need to find the additional money to settle.

Some tips when buying off the plan using a SMSF borrowing arrangement:

• Ensure there is a single contract – this is especially important with a house and land type of deal – your SMSF cannot buy land then get a construction loan. There is nothing in the legislation preventing multiple drawdowns, but typically the lenders will want the SMSF paying the deposit and any progress payments, and then only provide finance at settlement after they have undertaken their final valuation of the completed property.

• One logistical problem is that there can often be a very short period of time between the property being finished with the title issued (if strata titled) and settlement.  This doesn’t give the bank much time to finalise everything and approve the loan before settlement.  The only way to work within these constraints is to work with your advisers and the lender to ensure as much of the work as possible is done, so it is just a matter of the valuation coming through to get the loan approved and the documents issued.  Ensure there will be at least two weeks for this to occur – more if possible.

Purchasing Shares

Although a lot of the focus on SMSF limited recourse borrowing is on property investment, it is worthwhile remembering that a SMSF can theoretically borrow to buy any allowable ‘single acquirable asset’ .  A single acquirable asset is basically one single asset, or a group of identical assets (i.e. 1,000 BHP shares).

Looking at listed shares, there are a couple of different ways you can utilise leverage within your SMSF:

• Your SMSF can invest in a geared share fund.  These types of managed funds have gearing built into them.  The distributions you receive are after all the costs of the borrowing and management fees are taken out.
• Your SMSF can utilise instalment warrants.  These can be traded on the ASX like ordinary listed shares and the borrowing is built into them (as is the interest cost).
• Your SMSF can use specifically designed products.  For example both Macquarie and NAB have equity lever / super lever products designed for SMSFs.  I have seen these products in action, and they work well.  The downside is the interest rate of course is quite high which eats into returns.
• You can set up your own self-funded borrowing arrangement for each individual parcel of shares.  This means a new holding trust / bare trust document for each individual shareholding – so if you wanted to buy 12 difference ASX shares, you would need to organise 12 holding trusts and 12 loan agreements.  This is obviously an administrative burden and relatively costly to maintain and monitor, but the advantage is that if you have available equity (or savings) outside of super, the cost of borrowing will be a lot lower than the equity lever type products available.

Where to now?

The biggest message I want to get across to readers is that they need to seek competent advice on anything relating to using a SMSF to build wealth – especially with SMSF borrowing arrangements.

What have I been up to?

As mentioned at the start of the article, I have not posted much on this blog in the last year or so.  There are a couple of reasons for this:  Firstly, I have been flat out in my role as the general manager of Superfund Partners, a specialist SMSF administration and advice business that has experienced significant growth over the last year and is showing no signs of slowing.  If you already have a SMSF, or are thinking about setting one up, and require a fantastic administration service at a great price back by an awesome team of professionals – please let me know.  I may even be able to swing a discount for any faithful EvolveMySuper readers!

Secondly, Superfund Partners has started another business designed purely to look after the SMSF administration needs of financial planners, brokers and accountants.  If you fall into one of these categories, please have a look at Superfund Wholesale (please note this service is only available to businesses – not individual SMSF trustees who will receive more from Superfund Partners).

Thirdly, if the above two weren’t enough to keep me busy, I have been project managing some pretty funky software development that ties in beautifully with our Superfund Wholesale adviser service.

If you have any questions on the above, please don’t hesitate to contact me.

All the best!

Kris

Please also ensure you follow me on Twitter: Kris_Evolved

Contributing hard earned personal savings into super to help fund the purchase of property is a difficult thing to ask where there is a long period of time until retirement where you can access that money again.

One strategy that can be utilised to get all the benefits of investing via a self-managed super fund (SMSF) without permanently losing access to personal funds before retirement is via the use of related party loans.

Before I jump into this very topical topic, I need to apologise for my less than stellar performance in regards to the frequency of my blog posts.  I have been absolutely flat out running the day to day operations of Superfund Partners – a specialist SMSF administration and advice business looking after hundreds of clients and advisers.

If you are a Twitterer (not sure if that is the correct term….) then I encourage you to follow me on Twitter (@Kris_Evolved).  If I don’t have time to write a full blog article on an interesting or relevant topic relating to SMSFs and wealth creation I normally will post a tweet with a link to an article or website.

Onwards….

I am going to cheat a little with this blog post and use the following video from BRR Media and provide some commentary on issues raised during the round table discussion.

Using available equity

Grant Abbott makes the point regarding utilising available equity on property owned outside of super to on-lend to a SMSF instead of or in addition to the SMSF obtaining a loan from a bank directly.  Although this has advantages around saving upfront and ongoing costs, there are a few disadvantages.

It may become difficult to re-structure loans that have been set up this way when the property outside of super is sold or refinancing is needed.  It also may eliminate opportunities for other geared investment outside of super (including property, shares or a small business) as the equity is being utilised by the individual who as on-lent the funds to the SMSF.

As I have previously written about, buying property inside a SMSF is not mutually exclusive with investing outside of super – you can and should do both when it comes to wealth creation.

Low interest rate loans

It is mentioned that the ATO has given the OK to related parties lending money to a SMSF at 0% interest for the purchase of assets (including property).  Although I do not disagree with Grant’s comments, it is something that seems too good to be true – especially for high net worth investors.

Think of it this way, if you have a large amount of money outside of super you could lend that to your SMSF to enable the purchase of multiple investments (including but not limited to property). The SMSF would only pay a maximum of 15% tax – or even 0% tax if the members are old enough to draw a pension.  In addition, there could be 0% interest on the loan meaning the individual receives no taxable income from the arrangement and pays no tax.

This strategy is incredibly attractive for individuals over the age of 60 who may have already maxed out their non-concessional contribution caps ($150,000 per annum or $450,000 where the two year bring forward is applied) but also have funds held in their personal names which they want to invest in a low tax (or zero tax) environment such as a SMSF.

Please also note that where money is borrowed from a bank by an individual and then on-lent to a SMSF, the loan between the individual and the SMSF should be at the same rate.

For a more detailed summary on this topic, please have a look at this article from Aaron Dunn of the SMSF Academy here:

http://thedunnthing.com/2012/08/30/zero-interest-in-smsf-borrowing/

Tax rates

Grant makes an excellent point about the ‘end tax rate’ – meaning the tax payable by an investor in the long term when a property is sold.  Where there is significant capital gains, a SMSF is always going to have a superior tax rate when compared to investing in other structures or investing in your personal name.  This difference in tax could be a deciding factor when determining the most appropriate purchase structure, or retrospectively assessing whether a particular property investment was successful.

I have previously covered this topic in more detail in this article: Is buying an investment property with your super better than negative gearing.

Superfund Partners also has a great calculator here which compares purchasing a property in your personal name compared to in a SMSF.

Borrowing more than 100% of the property value

Because a SMSF can combine bank loans of up to 80% for residential property with loans from members / related parties, it is possible to create a situation where the loans relating to the property are more than 100% of the property value.

The only reason I think a SMSF can justify doing this is where the available cash within the fund needs to be preserved to enable improvements / renovations to be undertaken and after the improvements are complete the increased yield from the property would enable the investment to be cash flow positive.

A key point is made here, a SMSF cannot borrow to improve an asset – it must use existing money in the SMSF.  More information on this can be found in the following article: ATO opens the door on SMSF property improvements.

I am typically against negative gearing when it comes to property because as an investor you are effectively gambling that any long term capital growth (less tax paid when you sell) will outweigh the year to year cash leakage from an investment that costs you money to maintain (even after personal tax savings / refunds).  The same applies within a SMSF – it is always preferable to have a cash flow positive property where the surplus cash and contributions can be built up and used for further investment and wealth creation rather than paying bank interest.

Specialist advice

Self-interest alert: A recommendation is made that advice is sought from a SMSF specialist adept at doing SMSF related party loans (as a standalone or together with a bank loan). Ensure the person you take advice from knows what they are talking about.  If you need advice or assistance, please contact me and I can help you directly or refer you onto someone suitable in your area.

The question posed by Ben Anderson wasn’t actually answered in regards to what documentation is required.  The following is a required when a SMSF borrows from a related party:

• Trust deed enabling limited recourse borrowings (should be no older than 2008 – but ALL trust deeds need to be reviewed)
• Loan agreement
• Loan repayment schedule
• Trustee minutes
• Investment strategy covering the investment, use of borrowings and also insurance for the member+

It is nice that Phil Allen recommends finding a SPAA accredited SMSF specialist such as myself (and plugs his company!).

Interest rates (again…)

The question has been asked to the ATO in June 2012 regarding low interest or zero interest loans.  Grant is right in stating that the ATO confirmed that the difference between a market (bank) rate and the low rate (0% / 1%) related party loan would not be considered a contribution.  However, it is important to note that there is no formal ruling or law on this – the ATO was just stating it’s opinion based on the question asked and it’s interpretation of the applicable law.

Another good point made is where money is on-lent to a SMSF from funds the member has borrowed from a bank that the interest rate should be the same.  I agree 100%.  What can be different though is the timing of when the interest is physically paid.  Interest income (that the SMSF would be paying to the member) is only taxable when it is physically paid.  This means there are opportunities for clever advisers to manipulate this to squeeze addition tax savings in certain situations.  This is similar to the pre-payment of tax deductible interest to bring a tax deduction forward where a person has higher than normal income in a particular year.

Understand the structure

Each and every SMSF should have a corporate trustee.  In addition, each individual property requires it’s own separate holding trust, however a single company can act as trustee of multiple holding trusts.  The company of the holding trust is a different company to the trustee company of the SMSF – they must be separate legal entities.

Insurance

Insurance, namely life insurance and total permanent disability (TPD) insurance are often overlooked in the excitement of setting up a SMSF.  There were changes to the super regulations on the 7th of August 2012 which now requires SMSF trustees to determine what insurance they need for the members.

The amount of insurance should be at least enough to pay out any loans the SMSF and member personally have borrowed.  Another important aspect is that the insurance premiums should not be allocated directly against the members benefits – they should be recorded as a general expense of the SMSF in the accounts.  There are some very important reasons for this, and although the SMSF will not be able to claim a tax deduction for the premiums when the premiums are recorded as a general expense, the benefits of NOT doing so outweigh the tax benefits.  I can guarantee that an overwhelming majority of accountants who prepare SMSF accounts for their clients do not know this and may do it incorrectly.

It is essential advice is obtained when entering into a SMSF property purchase using borrowings.  Typically, a bank will require a financial planner to sign off that the client has obtained appropriate financial advice before they approve a loan.  To enable a financial planner to give this advice, they are generally need to prepare a financial plan (statement of advice).

My advice is that because you are effectively forced to get this advice that you make the most of it.  That means you should get your the financial planner to undertake detailed cash flow analysis of a potential property purchase, organise the rollovers from your existing retail or industry super funds, provide recommendations on appropriate insurance (with the best premiums) and also liaise with your lawyer and bank / broker to effectively drive the process from start to finish.

$50k – enough to set up a SMSF and buy property?

Grant makes a comment regarding apartments costing $250k returning $350 per week rent – 7.28% gross yield – not too bad.  Borrowing using a 80% LVR a SMSF would only need a $50k deposit to purchase the property.

There is a little more to it than that of course – please refer to previous points above.  If you area  couple and you and your partner each have $50k in super (total $100k plus) – then a SMSF is a lot closer, and the more you have to invest, the more options you have in terms of selecting an appropriate, quality property.

Regardless of how good the strategy is, if the property supporting it is poor quality in terms of the cash flow it can generate and capital growth it can obtain, your super and your wealth will not grow at its full potential.

The clock is ticking…

The Government has flagged a review of the SMSF limited recourse borrowing arrangements – so don’t sit on your hands and watch this opportunity sail by.  Do your research, seek professional advice and take control of your wealth creation and your super!

Your next steps

1. Any questions? Comment below or contact me.
2. Get my comprehensive guide to buying property with your super here
3. Set up your SMSF here

One of the most common enquiries I receive is in relation to using super to purchase NRAS (National Rental Affordability Scheme) properties.

When I first heard of NRAS and how it worked I was sceptical.  I asked myself “is this just a glossy, well marketed property spruik with dubious investment value?”

To answer that question, I do what I normally do – researched, asked questions and of course ran the numbers to see how they stacked up.

How does NRAS work?

NRAS basically works as follows:

• A developer will apply for a number of its properties in a development to become NRAS approved
• These properties will be leased to certain approved applicants (often government employed professionals such as police, nurses etc. – it is not social housing)
• The market rent is discounted by 20%
• Market rent is indexed annually based on the residential rent component of inflation
• Properties are managed by an approved manager
• Properties can be in the NRAS scheme for up to 10 years, but can be removed from the scheme and/or resold as per normal
• To compensate for the reduced rent, the investor (which can include a SMSF) receives a combination of refundable tax offsets (Federal Government) and a non-taxable State Government incentive
• The offsets and incentives currently amount to $9,524 per annum and these amounts will also be indexed annually

Please note that the above points are simply a summary.  There is a lot more information available online that covers how NRAS works in a lot more detail.

What is the benefit of buying an NRAS property?

Firstly, it is important to understand that an NRAS approved property is physically no different to any other property in a new development – it simply has been granted the NRAS status.

Secondly, taxation or any government incentive should never entirely drive an investment decision – sure – take them into consideration, but the underlying qualities of the investment are always the most important drivers.   The same applies for NRAS investments – if the NRAS scheme was not there tomorrow, would the investment still make sense?

The real benefit of investing in an NRAS property compared to a normal investment property comes down to maths.  The $9,524 government incentives are a flat annual amount – regardless of the property type, value and rental income.

This means the incentives have a larger positive cash flow impact on properties with a lower market rent, for example:

As we can see from the above comparison, the lower the original market rent, the greater the impact of the NRAS government incentives.

WARNING: The above is simply one factor which needs to be taken into consideration when purchasing an investment property.

An interesting point I discovered while undertaking my research is that some developers will choose specific lots / properties within their developments that will have NRAS status attached when they are purchased.  The investor has no choice.

By comparison, other developers will not specify the exact lot or property, meaning they will have a certain number of different property types (houses, duplexes, terraces, units) within their developments for which they can allocate NRAS status if the investor chooses.

The latter option provides investors with a lot more flexibility and ensures you are not purchasing a discounted rent NRAS property in a group of other discounted rent properties.

How do I use my super to buy an NRAS property?

Before going down the path of using your super to purchase any kind of investment property, including an NRAS property, you need to do the following:

1. Read these articles:
• How much is needed to set up a SMSF
• Why you shouldn’t set up a SMSF
• 5 reasons why you need a company as trustee of your SMSF
2. Download my free guide book:
• SMSF Borrowing 101 – How to buy property using your superannuation
3. Research potential properties and gather as much accurate information as possible
4. Utilise the free calculator and other resources available on my website:
• Calculator
• Resources

Before even setting up a SMSF or committing to any property purchase, you should already have a very good understanding of how much you will need to have in your SMSF to complete the purchase, and what the ongoing cash flow situation of the property will be.

Rather than providing significant detail in this article in regards to the actual process you need to follow (tested by me with numerous clients with a 100% success rate), I again recommend you read my free SMSF Borrowing 101 guide.

The key difference between a NRAS property investment within a SMSF and a normal property purchase comes down the available lenders.

SMSF loans and NRAS property purchases

With limited recourse SMSF loans, there are a limited number of lenders available.  When you combine this fact with available lender for NRAS properties, the pool of lenders shrinks dramatically.

Based on my research, there are three, maybe four lenders who even have a policy on NRAS SMSF loans.  It is also important to note that some lenders will not lend on certain properties from specific NRAS consortiums.

The following is a summary of important considerations / criteria that you need to be aware of when it comes to applying for a SMSF loan for an NRAS property:

• All lenders will require a letter / sign off form from a financial planner that you have been advised on all relevant aspects of buying a property in your SMSF (this basically means you must have a financial planner prepare a Statement of Advice / financial plan specific to your property investment)
• With NRAS properties, or any new off the plan property for that matter, a bank valuation may be up to $30,000 less than the contract price – the assumption being this is the amount of marketing costs built into the final completed property
• The lenders will generally include only 80% of the discounted rent (i.e. 80% x 80% = 64%)
• The $9,524 annual government incentives are typically ignored when the lender is looking at the SMSFs ability to service the loan
• Contributions income (employer contributions and salary sacrifice) can be used in the serviceability calculations if needed
• Maximum loan amount is 80% of the property value (assume the value is up to $30,000 than the advertised price / contract price)

The above criteria a significantly different to the expected cash flow outcome of an NRAS property investment within a SMSF.  The impact of the above is that you may need significantly more money with your SMSF to complete the purchase of an NRAS property than you might expect at first glance – this is why it is so important to do your research, crunch the numbers and always seek competent specialist advice.

Does NRAS investment in a SMSF make sense?

If you have read my other articles, you will know that I am obsessed with cash flow positive investment as a key wealth building tool.

What I like about NRAS property investments is that they can boost the amount of cash flow generated from a property – which is fantastic.  What I don’t like is slick marketing which may potentially mislead investors – this is why I want to provide you with the tools and information you need to make an informed decision.

Wills and SMSF Estate Planning

SMSFs are the investment vehicle of choice for a huge number of Australians – which is no surprise considering the control and flexibility they offer.  Although most of us ensure we have valid death benefit nominations in place covering our superannuation monies, we need to ensure these nominations are also integrated with our personal Wills to form an overall estate plan.

Your personal Will does not govern your SMSF benefits

The payment of benefits from a SMSF, including benefits paid upon the death of a member, is covered by the rules contained in the SMSF trust deed – not the Will of the deceased member.  This was confirmed by the ATO in determination SMSFD 2008/3.

Your Will however is still critically important when putting together your estate plan for a couple of reasons:

1. Where SMSF benefits are paid to the legal personal representative, they then become part of the estate of the deceased member to be distributed with their other assets.
2. The Will determines who becomes the executor of the deceased individual’s estate (i.e. the legal personal representative).

The legal personal representative generally will step into the place of deceased individual trustee (or director of the trustee company) – however this does not happen automatically on death of the member as most people (including accountants and advisers) believe. The legal personal representative still needs to be appointed as per the rules contained within SMSF trust deed.

The legal personal representative has significant control over how death benefits within a SMSF are paid – however they still have to comply with any valid (unexpired) binding death benefit nominations that are in place.

Equalisation Clauses

A well drafted trust deed can contain an equalisation clause (also known as a ‘hotchpotch’ clause).  These clauses take into consideration benefits received directly from a SMSF when distributing the residual assets from an estate.

For example if an individual passed away with $1 million in a SMSF and $1.6 million in other assets outside of super (total asset pool of $2.6m) and that individual wanted all their assets split evenly between their spouse and adult child upon their death, the executors could have the spouse receive only $300k from the estate plus $1 million from the SMSF.  The remaining assets of the estate ($1.3 million) could then be distributed to adult child.

This flexibility is also significantly more tax effective as a financial dependent such as a spouse can receive death benefits from a SMSF entirely tax free, whereas a non-financial dependent adult child would lose 16.5% tax on the taxable component of the deceased members benefit within the SMSF.
 

Formula for a solid SMSF estate plan

• Ensure all members have a well drafted and up to date personal Will and Powers of Attorney

• Look at a re-contribution strategy to wipe out as much of the taxable component within the members benefit as possible

• This is ideally done between the ages of 60 and 65
• Having a low taxable component reduces or eliminates tax when death benefits are paid to a non-financial dependent such as an adult child

• Utilise a good quality and up to date SMSF trust deed

• Any trust deeds dated prior to 2007 should be updated to take into account significant changes

• Make use of a special purpose trustee company for your SMSF

• This enables the SMSF to continue to operate upon the death of a member
• A corporate trustee means all the investments do not need to be changed to the name of the new trustees upon the death of one member
• Take control now and save significant headaches at a time where mountains of paperwork will be the last thing your spouse will want to deal with
• Only ongoing cost is an annual $43 fee to keep the company registered

•  Make your pensions automatically reversionary to your spouse

• Having an existing pension continuing to be paid to your spouse upon your death is the cleanest and most tax effective way of managing your SMSF benefits
• The receiving spouse will generally have the option to commute or stop the pension partially or in full if they want a lump sum
• The automatic reversion of a pension is not considered a superannuation death benefit and actually comes before or overrides any binding death benefit nominations that are in place
• A pension, and thus the tax exemption on the income within the SMSF, stops when that pension member dies.  An automatic reversionary pension ensures that there is no unnecessary addition tax paid by the SMSF.

Summary

Unfortunately not all lawyers have expert super knowledge, and even fewer have adequate SMSF knowledge.  Likewise, your accountant or adviser cannot put together an estate plan for your SMSF in isolation – it needs to be completed as part of an overall estate plan covering both super and non-super assets.

A few weeks ago the ATO issued a draft ruling enabling SMSFs to renovate and improve properties purchased under limited recourse borrowing arrangements.  This ruling takes a very common sense approach and removes a lot of the confusion surrounding this issue.  Please refer to my article Repairs vs improvements with property purchased under a SMSF loan.

Prior to this ruling being issued, it was not possible for a SMSF to improve property purchased through a limited recourse borrowing arrangement – regardless of the source of funds for the improvements.  The ATO indicated that improvement to the property would create a replacement asset, and the arrangement would need to be unwound – not a good outcome for SMSF trustees.

The ruling (SMSFR 2011/D1) now enables a property purchased under a limited recourse loan arrangement (i.e. after 7 July 2010) to be renovated or improved, provided the following conditions are met:

1. The source of funds for the improvements come from within the SMSF (i.e. not borrowed)
2. A replacement asset is not created

Although we can now renovate and improve a property purchased under a SMSF borrowing arrangement, we need to ensure that the improvements are paid for by existing monies within the fund – not from borrowings.

This means if you are looking to purchase an older dilapidated property and renovate, you need to ensure that you have budgeted for all the relevant renovation expenses knowing that you will not be able to go back to the lender and borrow more as you can outside of super. To put it another way, you need to preserve as much cash within the SMSF as possible to enable the renovations to be paid out of the SMSFs own money.

One great strategy you can utilise to achieve this is to use a second loan from the members of the fund in addition to a bank loan – please refer to the relevant section within my ebook for further information on this strategy.

Before this ruling was released, a key distinction was between what constitutes a repair, and what constitutes an improvement.  The key question now is: When does an improvement create a replacement asset?

There are two main times where improvements can create a replacement asset (which is prohibited with property bought under a limited recourse loan):

1. The property is physically altered in such a way that is has a different function or purpose
2. The legal rights associated with the property are altered

For example, converting a house to a dental surgery would be create a replacement asset as the property has a different function – i.e. it is no longer a residential home.

Any changes to the title of a property, such as sub-division or creating strata titles would also create a replacement asset(s), which is strictly not allowable under the limited recourse borrowing rules.

Taking into account the above limitations, there is still a very large scope for what can be done to a property under a limited recourse borrowing arrangement.  Please refer to the ruling for further examples.

Single Acquirable Asset

Another positive change to come out of this draft ruling is the definition of a single acquirable asset has been updated.

In regards to property, this means where a single property spans across two or more titles and cannot be sold or dealt with separately, then it will be considered a single acquirable asset. Previously a separate custodian trust would be required for each title, but now the separate titles can be purchased as if they are one single property.

For example, a factory that covers two adjacent lots or an apartment with a car space on a separate title would still be considered a single acquirable asset.

A word of caution however – just because either the vendor or the purchaser want to deal with the separate titles as a single property, it doesn’t make it so.  This is especially relevant with farming properties, as they are often comprised of a number of adjacent titles that can be dealt with individually.

Summary

The issue of SMSFR 2011/D1 is a fantastic common sense development, and will provide property investors which a huge amount of confidence, certainty and flexibility when it comes to property acquisition (and renovation).  The ruling increased weight to the argument that a SMSF should be the preferred vehicle for purchasing any property investment that is going to be held long term.

Even though this ruling is still in draft format, based on the feedback from within the industry, SMSF trustees should be confident that the ruling will be finalised without too many changes.

Want to get started on your own SMSF property purchase?  I suggest you take the following steps:

• Sign up for the free newsletter and download a copy of the free SMSF Borrowing 101 ebook
• Purchase the comprehensive guide
• Analyse your potential SMSF property purchase using the calculators on the Resources page
• Set up your SMSF and order your custodian trust documents through the document portal
• Contact me for further advice and assistance