Related Party Loans for SMSF Property
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.
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:
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.
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, 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
- Any questions? Comment below or contact me.
- Get my comprehensive guide to buying property with your super here
- Set up your SMSF here