February 19, 2011

How business owners can BUY their premises using their super – Part 2

By Kris Kitto

In business one of the highest overheads you have is rent.  Would you rather all that rent money going into your landlord’s pockets or funding your retirement nest egg?

Due to recent changes to the superannuation laws, you are now able to combine your existing superannuation savings with a special type of loan making it possible to own your business premises without the previously required large amount of capital.

This article follows on from the previous article: How business owners can BUY their premises using their super – Part 1

How much will it all cost?

Purchasing a property in your SMSF via a custodian trust and limited recourse loan will definitely be more expensive than purchasing a property in your personal name.

However the additional upfront and ongoing costs will be offset by the fact that you are using your current superannuation savings – a pool of funds that was previously unavailable.

To give an example of the costs, let’s assume that you are looking to purchase a property worth $500,000 with a limited recourse loan of $325,000 (65% L-V-R):

SMSF establishment (including company trustee) $1,600

Custodian trust (including company trustee) $1,800

Professional advice fees (legal & SMSF advice) $3,100

Bank legal costs $2,500

Loan establishment fees (1%) $3,250

Total $12,250

In this example your SMSF would need to have $175,000 to cover the purchase price plus $12,000 for the above costs and just over $25,000 for stamp duty. You should also budget for unforseen expenses and costs relating to the purchase – meaning you would need approximately $225,000 to comfortably purchase this $500,000 property.

There are also ongoing costs to operate a SMSF. These costs are summarised as follows:

  • Annual SMSF accounting & audit costs $2,000 to $3,000
  • ASIC fee for SMSF trustee company $41
  • ASIC fee for custodian trustee company $218
  • ATO SMSF Levy (paid with your SMSF tax) $150

Although the above may seem like a lot, you would have a similar level of costs if you purchased the same property in a family trust.

The applicable interest rate on a SMSF limited recourse loan vary from lender to lender but will generally be higher than a residential property loan. As a rule of thumb take the standard variable rate of the lender (currently averaging around 7.70%) and add 1%.

If you and your business currently have a high level of borrowings with one lender (i.e. there is a lot of risk for that bank) you should add 2% to the standard variable rate.

As previously mentioned, if you utilise existing equity you have in other properties and on-lend those monies to the SMSF to fund the purchase, you will generally reduce the interest rate down to the same rate you are paying on your personal home mortgage.

This makes the ‘member-financed’ option more attractive – however it does tie up this source of capital for future investments and business expansion funding.

What types of properties are suitable?

Your SMSF is able to purchase any type of property as an investment; however the property cannot be used personally by the members of the SMSF or their families. This means no holiday homes you want to use personally or cheap rent (or even market rent) for a family member.

From the banks perspective you should be able to purchase any property that is income producing. This may include:

  • Residential properties
  • Shops
  • Warehouses
  • Factories
  • Strata-title offices
  • Medical suites or surgeries
  • Income producing land
  • Farms and rural properties*

*Loan to value ratios for rural properties are generally significantly lower – i.e. 50% or less.

Each lender has their own lending criteria so it is best to speak with a mortgage broker who can find the most suitable limited recourse loan for your SMSF property purchase.

It is also possible for your SMSF to purchase business related property (but not residential) from the members and their related entities. There are also significant capital gains tax rollover provisions available for business owners which reduce the transfer costs of the property to the SMSF. Most States also offer some form of transfer duty / stamp duty relief to transfer a commercial property into a SMSF (except Queensland).

What are the restrictions / downside?

Overall, the ability for a SMSF to borrow using a limited recourse loan is a great strategy enabling business owners (large and small) to tax effectively purchase a premises for their business without the previously required large amount of capital.

However, there are some key limitations and restrictions that apply when a SMSF purchases a property using a limited recourse loan:

  • Any built up equity (via capital growth or loan principal repayments) cannot be accessed and redrawn. For this reason I recommend that any interest only periods on the loans be taken advantage of enabling the SMSF to build up surplus cash for further investment rather than reducing the principal on the loan.
  • Property owned by the SMSF via a limited recourse loan cannot be developed, sub-divided or improved as this may cause a ‘replacement asset’ which is prohibited under the laws that govern SMSFs. This is also relevant when a property is damaged by flood, fire or other natural disasters – even with the insurance proceeds a SMSF may not be able to rebuild without selling the damaged property out of the fund.
  • Leasehold improvements such as shop and office fit-outs can be made to the property, however these cannot be funded by the SMSF – they must be paid for by the business.
  • Market rent must be paid from your business to your SMSF for the lease of the property. Any unpaid rent needs to be treated the same way as if the tenants were an unrelated party.

The cherry on the top:

Many business owners perceive their business as being ‘their super’. This has been recognised by the Government and for this reason there are significant CGT concessions available that enable business owners to put over $1.1 million each over their lifetime into super from the sale of a business without those amounts not counting towards the contribution caps.

In addition, if you as a business owner decide to retain your business premises (in your SMSF) and lease them to the new owner, if you commence a pension from your SMSF once you turn 55, then the rental income received from the property with be 100% tax exempt.

Tax free income without having to retire to a Carribean tax haven – fantastic!

Summary:

For business owners, using your super to purchase business premises with a SMSF with a limited recourse loan has the following advantages:

  • Lower capital outlay (from business funds or personal savings)
  • Superior asset protection – super assets are protected from creditors
  • Tax effective investment with no Div7A loan or other tax problems
  • Tax exempt income flowing into the SMSF from age 55 and tax free pension income for the business owner from age 60
  • Monies paid by the business into the SMSF as rent do not count towards the restrictive contribution caps – meaning more money can be put into a tax effective environment
  • Business owners must have their business accounts and personal tax affairs in order before signing any contracts or applying for a limited recourse loan
  • Need to be aware of the restrictions, additional costs and projected cash flow of the investment
  • The loan application process will take longer than a normal property purchase – ensure you have extended finance and settlement periods in the contract

How can I help?

I am in the unique position of being one of the few accountants and SMSF Specialists in Australia who has a proven history of helping business owners purchase commercial property using their super.

I can work with you and your accountant to do the following:

  • Undertake a cash flow analysis to determine how much you require to purchase your desired business premises and what the annual cash flow position will be
  • Determine an appropriate strategy for you to get the required capital into your SMSF to enable a purchase
  • Establish a new SMSF for you or attend to the upgrade of your existing SMSF to ensure that it is able to borrow and also will get through the banks rigorous legal reviews
  • Set up the custodian trust and trustee company which will be the legal owner of your property
  • With the help of our in-house mortgage broker determine the most suitable SMSF limited recourse loan provider and loan structure for your situation
  • Liaise with your chosen lender and step you through the entire SMSF property purchase process all the way through to settlement
  • Provide an accountant sign off confirming that the SMSF limited recourse loan strategy if suitable for your situation (required by the banks)
  • Undertake the ongoing annual accounting work for your SMSF via the market leading Superfund Partners system which provides you with cost effective SMSF administration and online access to up to date reports
  • Arrange the annual audit of the SMSF through one of our independent SMSF specialist auditors

How do I get started?

Firstly I recommend you download a read the SMSF Borrowing 101 guide by entering your name and email in the box on the top right of screen.

Secondly you need to contact me so we can get started on your SMSF business premises purchase.

If you have any questions or comments, please don’t hesitate to share them below.

In business one of the highest overheads you have is rent. Would you rather all that rent money going into your landlord’s pockets or funding your retirement nest egg?

Due to recent changes to the superannuation laws, you are now able to combine your existing superannuation savings with a special type of loan making it possible to own your business premises without the previously required large amount of capital.