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.

I am recruiting!

In addition to writing articles for EvolveMySuper, I also run specialist SMSF accounting and advice business Superfund Partners.

Superfund Partners HQ is located at Southport on the Gold Coast, and I can honestly say that we do not operate like other accounting businesses.  We focus on squeezing all the possible benefits and efficiencies from technology, and use these time savings to improve the service and advice we give to the SMSF trustees and advisers we work with.

Due to the rapid increase in the number of clients and businesses that are working with us, we are looking for some awesome people to join our dynamic and talented team.

Positions available:

• Undergraduate Accountant
• Graduate Accountant
• Intermediate Accountant

Undergraduate Accountant:

Our undergraduate position will suit you if you are currently completing your undergraduate degree (either full time or part time) and are looking for a flexible position that works in with your uni schedule, while providing practical real world experience in a supportive environment.

Undergraduate applicants need to have:

• Excellent written and verbal English communication skills
• Ability to work well within a team environment
• Attention to detail
• Above average computer skills
• Energy to burn and passion to learn
• Mature aged students encouraged

Graduate Accountant:

Our graduate position will suit you if you have completed your accounting degree and have commenced (or are looking to commence) your professional career with a dynamic and high performance company.

Graduate applicants need to have:

• Excellent written and verbal English communication skills
• Ability to work well within a team environment
• Attention to detail
• Existing industry experience in accounting, financial planning or banking will be very well regarded
• Applicants with related industry experience welcome to apply

Intermediate Accountant:

Our intermediate accountant position will suit you if you have been working in public practice and are looking to specialise in self-managed superannuation.  We provide support for further career development and training including the Chartered Accountants, CPA and SPAA specialist programs.

Intermediate applications need to have:

• Excellent written and verbal English communication skills
• Ability to work well within a team environment
• Public practice accounting experience with SMSFs
• A passion for self-managed super

What we offer:

• Excellent team culture
• Flexible working hours enabling a work life balance that enables you to give your best!
• Opportunities to grow with a growing company in a dynamic industry
• Quality formal training
• Opportunity to work with experienced and well regarded industry professionals
• Above average remuneration for the right candidates

If you would like more information about the positions available, or reckon you have what it takes, please contact me.

Remember – if you are a subscriber to EvolveMySuper, you already have a massive head start on the other applicants!

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

A common question SMSF trustees who invest in direct property have is: When does our SMSF property investment need to be revalued?

In this article I will not only confirm when properties held by SMSF need to be valued, but also how they can be valued and who can value them.

Why SMSF property investments must be revalued?

There are four main reasons why SMSF trustees need to revalue any real estate investments held by their fund:

1. Pensions – when a SMSF commences a pension, the value of the underlying investments that support that pension need to be determined to accurately calculate the minimum and maximum pension amounts.
2. Performance - it is essential for SMSF members and trustees to be able to measure the performance of their investments – which needs to include any change in the valuation of real property.
3. In-house Assets - SMSFs are limited to having 5% of their assets invested into ‘in-house’ assets.  For this ratio to be accurately measured, all investments of the fund must be valued at fair market value.
4. Contribution Caps - the current Labor government has slated a reduction in the current $50,000 concessional (tax deductible) contribution cap to a measely $25,000 for persons over the age of 50 where their member balance exceeds $500,000.  To accurate determine whether the lower cap will apply, all assets of the SMSF need to be accurately valued at market value.

When MUST property in a SMSF be revalued?

The ATO in Superannuation Circular 2003/1 has stated “self managed superannuation funds should use market value reporting for their financial statements” – considering that each SMSF must prepare accounts each financial year, then it makes sense that market valuations for any property held by a SMSF should also be valued each and every 30 June right?

Not necessarily….

SMSFs are generally not considered to be reporting entities, and hence they are not forced to comply with the same strict reporting standards as larger superannuation funds.  If you look at the ATO Circular mentioned above, it uses the phrase “should use market value reporting” – NOT “must use market value reporting”

However, SMSFs trustees do not get off the hook that easily.  The independent auditor of the SMSF each year must ensure that the financial statements are presented are a fair and accurate representation of the assets of the fund.  The following is an extract from a 2011 SMSF audit report:

SMSF auditors (the competent ones at least) take the above very seriously – and I would too in their situation.   The auditor of the fund must be provided with evidence that the valuation of any property held by the SMSF is valued accurately enough for them to sign off on the above Auditor’s Opinion.

The general rule of thumb used by the majority of SMSF auditors is that property investments held by a SMSF must be valued at least every three years.

There are some situations where property held by a SMSF must be revalued on a more frequent basis:

• When a pension is commenced, a valuation from within 12 months prior to the commencement of the pension must be used
• When the auditor believes that the valuation used in the accounts is either too high or too low
• Where the SMSF has in-house assets and the auditor needs to ensure that the 5% in-house asset ratio has not been exceeded

The most important (and most common) exception of the above three is when a pension is commenced.  Many SMSF members who have started a pension still contribute to their fund on an annual basis.  This means that a new pension is potentially started each year.  In this situation, Tax Determination TD 2000/29 will require the trustees to undertake a valuation each year, as the valuation must be within 12 months prior to the commencement of the pension.

Who can undertake the valuation?

When it comes to obtaining the actual valuation of a property, it does not always needs to be done by an independent valuer.  It is not so much who does the valuation – rather how the valuation is performed which is the key factor in determining whether the valuation can be relied upon by the auditor or not.

Valuations can be conducted by:

• Independent valuers
• Real estate agents
• Other unqualified persons (including trustees of the fund)

From an auditors perspective, something from an independent party holds a lot more weight than something from a trustee of a SMSF.

The method of determining market value – the ‘how’ is significantly more important than who conducts the valuation.  The methodology must be objective, based on a reasonable process, take into account all relevant factors and be able to be explained to a third party.

For example, when determining the valuation of property, the following factors would be considered:

• the value of similar properties
• how much was paid for the property
• valuations for council rates purposes
• independent appraisals
• rental yield

For SMSF trustees wishing to complete their own valuations, for residential properties they should obtain either a Street Sales History report or a Suburb Sales History report from RP Data.  These reports are significantly cheaper than a full independent valuation, and they can form the basis for the valuation of the SMSF property – especially when combined with information freely available from RealEstate.com.au and similar sites.

When it comes to commercial, industrial and other more unique properties that a SMSF can hold as part of its investment strategy, it becomes more complex.  The above historical RP Data reports may provide some helpful information, however more detailed analysis will normally be required to obtain a valuation that will be accurate enough to satisfy the auditor.

In these situations, an independent appraisal should be obtained every three years, and the methodology used in the valuation combined with up to date market information (freely available on the internet) to determine valuations in the intermediary years.

Summary:

SMSF trustees wishing to undertake their own property valuations need to be aware of the above requirements and their obligations to the auditor, the ATO and themselves as members of the fund.

Any questions or comments about this article?  Please feel free to comment below or contact me.