Members of a self-managed superannuation fund (SMSF) looking to acquire property through the fund need to be aware of the risks involved in the strategy or risk substantial penalties.
One of the considerations investors should be making if they are deciding to put a property in their SMSF is whether the strategy will improve retirement outcomes. Ultimately, investment decisions, such as the aforementioned strategy, will have ramifications for whether members have a comfortable retirement or need to rely on government support.
SMSF members should also consider the liquidity of the current assets in the fund. As property is a large, illiquid asset the fund should have enough cash on hand to pay day-to-day expenses. If the property is the only asset in the SMSF and it is in pension phase, it may not be able to supply a sufficient retirement income to its members.
Members purchasing property through debt have several restrictions on their investment under the limited recourse borrowing arrangement (LBRA). To establish an LBRA, a 20 per cent deposit is required and enough money to cover stamp duty and legal expenses within the SMSF, or ready to roll over from another super fund.
The fund will be assessed on its borrowing potential based on members’ superannuation contributions and the rental income from the property. Lenders will often require a personal guarantee from the SMSF trustees as the lender can repossess the property if an SMSF cannot meet its repayments.
In addition, if property is purchased using debt any improvements made to the property cannot change the nature of the property. Improvements must be paid for by cash in the fund rather than using further borrowings to pay for expenses.
Investors need to ensure they meet the obligations of the fund, such as having sufficient cash held in the fund. If the member isn’t receiving contributions, or the property is vacant for a period, then the fund will risk becoming a non-complying fund and may face severe penalties.