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Basic ingredients for using gearing to buy property

The use of limited recourse borrowing arrangements to acquire property for an SMSF can be a very powerful, worthwhile but complicated strategy to employ. Julie Dolan lists the items that need to be in place to ensure the plan is executed properly.

Christmas is behind us and we are well and truly into the new year. It may have been one of your new year resolutions to get your finances in order and cement some of your goals to achieve a retirement you so richly deserve. This may include looking at jumping into the property market.

If you are thinking of using your SMSF to acquire a property via borrowings, you need to make sure you do not jump in blind on a purchase. Make sure you seek independent specialist advice during the complete process, otherwise it can be a very expensive and painful exercise.

An SMSF can borrow based on strict rules under the Superannuation Industry (Supervision) (SIS) Act 1993. Each step of the arrangement and continual maintenance of the borrowing arrangement must comply with these rules.

As trustees, you can be personally liable for hefty non-compliance penalties, as well as the potential wind-up of the fund and borrowing arrangement.

Seeking the correct advice not only ensures compliance with the SIS Act, but also allows you to acquire the property in a very flexible and tax-effective structure.

Here is a basic checklist you can use in conjunction with independent specialist advice to make sure you can purchase a property in the correct manner:

  1. Make sure you have pre-approval of finance before signing any contracts of purchase.
  2. Check the fund’s trust deed to make sure it allows for limited recourse borrowing arrangements (LRBA) and the potential transaction is consistent with the terms of the trust deed.
  3. Is the potential property purchase allowable as part of the fund’s investment strategy in terms of risk, return, diversification and liquidity?
  4. Borrowing arrangement documentation needs to be compliant with section 67A of the SIS Act.
  5. All terms of the borrowing arrangement must be on arm’s-length terms, otherwise the income of the fund can be assessed as non-arm’s-length income and taxable at 47 per cent. This is especially important if there are loans made to the SMSF from a related party.
  6. External financiers will usually require a corporate trustee for the SMSF.
  7. It is necessary to establish a holding trust structure and trustee and to make sure they comply with section 67A of the SIS Act.
  8. Correct naming on the contract depends on what state the property is located in.
  9. As trustee of the SMSF, the initial deposit for the property is to be paid by the fund.
  10. On settlement, the property is to be transferred directly from the vendor to the holding trust trustee on settlement.
  11. As trustee(s) of your SMSF you are not to hold legal title to the asset until the loan is repaid. Up until this stage, the fund has beneficial interest in the property only.
  12. If the property comprises several legal titles, separate LRBA and holding trust structures may be required.
  13. Money borrowed under an LRBA can be used to repair the property (but not to improve it).
  14. The property must not be subject to a charge or mortgage, except as required under section 67A of the SIS Act.
  15. The in-house asset exemption for LRBAs relies on the asset being the only property of the holding trust.
  16. Any recourse of a lender against you as SMSF trustees for a default on the borrowing must be limited to the underlying asset.
  17. The SMSF then manages the asset. All rent, expenses and loan repayments paid to and by the SMSF. The holding trust does not need to register for an Australian business number or goods and services tax, nor establish a bank account or lodge tax returns.

There are complexities and specific steps that need to be adhered to in a certain order for the borrowing arrangement to be implemented and managed correctly.

Putting steps in place with the assistance and advice of a specialist adviser will give you that peace of mind while ensuring compliance with the super rules.

SMSFs can be a very effective vehicle to purchase and leverage property if done properly, but seeking professional advice before employing this type of strategy is always recommended.

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