The things you need to know about auditing your SMSF
SMFS audits are required before you file your fund’s annual tax returns.
08 Feb, 2023
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- Access your SMSF loan via our easy-to-use online app Smart Money
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Borrowers who are making contributions to their self-managed super fund (SMSF) can take advantage of an SMSF loan to finance an investment property.
To have a deeper understanding of SMSF loans, borrowers must first have a good grasp of the concept of SMSF and how it is run. In essence, SMSFs work similarly to other funds that help borrowers save for retirement. The difference, however, is that members of an SMSF (usually up to six) are also the trustees and are ultimately responsible for complying with super and tax laws.
What is an SMSF loan?
An SMSF loan refers to financing that allows SMSF to invest in property, providing an opportunity for the fund to buy larger value assets.
SMSF loans are typically used to fund residential and commercial property purchases, which are used to help grow the members’ retirement savings.
It is crucial to take note, however, that any property financed through an SMSF loan must not be used for the benefit of a fund member — this means that the property cannot be lived in or rented out to a member or any related parties.
SMSF loans cannot also be used to acquire assets from a member.
However, an exception to the rule is when the financing is used to invest in commercial property — this can be leased to a fund member for their business provided that the lease follows the current market rate.
How does an SMSF loan work?
A legal SMSF loan is in a limited recourse borrowing arrangement or LRBA.
In an LRBA, an SMSF trustee takes out a loan from a third-party lender. This trustee, then, utilises the funds to purchase a single asset to be held in a separate trust.
Any investment returns earned from the asset go to the SMSF trustee.
In the event that the loan defaults, the lender’s rights will be limited to the asset held in the separate trust — this means that the other assets held within the SMSF will not be affected, only the one in which the loan is secured against.
Which lenders offer SMSF loans?
Not all lenders offer SMSF loans — those that do often charge higher interest for SMSF loans than for regular home loans, since they are designed for the purchase of an investment commercial or residential property.
Here are some lenders that offer SMSF loans:
- Firstmac
- loans.com.au
- Liberty
- La Trobe Financial
- WLTH
How much money in SMSF is needed to buy property?
As of the end of June 2020, SMSFs had assets of over $1.3m on average. Meanwhile, 94% of SMSF members had a balance of below $1.6m, with the remaining reporting balances of over $1.6m.
Lenders typically require SMSF to have around 10% to 20% in their account after the proceeds of the settlement. This is to ensure that the fund can pay for any expenses that could potentially occur after settlement.
How does the SMSF loan application work?
Applying for an SMSF loan to purchase property works similarly to applying for a regular home loan. However, there may be some tweaks prior to and post the application. Here is how an SMSF loan application generally works:
- The SMSF trustees identify the property they want to purchase by considering factors such as potential capital gains, rental income, and market value.
- One of the trustees will act as the custodian — this person will hold the property title on behalf of the fund until the loan is paid off.
- The custodian submits the documentary requirements of the home loan application.
- After the bank greenlights the application, the custodian will put the property up as security.
- Stamp duty and other legal fees must be paid.
- Repayments can be made after settlement — rental income is used to pay off the loan. In case the rental income is not enough, SMSF contributions can be used to cover the deficiencies.
- The title of the property can be transferred to the SMSF once the loan has been paid off.
How do banks assess SMSF loans?
Just like with regular home loans, lenders often have their own criteria when assessing SMSF borrowers.
However, one of the most significant challenges SMSF borrowers have to face is ensuring that the funds are able to cover the servicing costs of the loan.
Some of the factors banks use to assess SMSF loan applications include the following:
- Contributions from the current employment
- Loan amount and the property value
- Deposit
- Savings out of the SMSF
- Income and employment stability
- Proposed rental income of the property
- Tax returns of the fund
What are the advantages of borrowing through SMSF?
Aside from the SMSF’s purpose of adding value to the retirement savings of the members, buying a property through an SMSF loan has several benefits:
Rental income is used to pay off the loan.
Properties purchased under an SMSF loan pay for themselves through rental income.
The fund can diversify its investments.
Another good reason to borrow through an SMSF is the LRBA — the fund can securely diversify into a property and increase profits in the long run.
There is access to higher-value properties
With an SMSF loan, funds can now take on investments of higher-value properties, some of which could be worth more than the funds themselves.
Borrowed funds can be used to cover repair costs.
SMSF loans can be used to repair existing fixtures and fund maintenance works in a property owned by the SMSF.
Trustees can take advantage of tax benefits.
SMSFs are typically taxed at a rate well below most Australians’ marginal tax rates. Furthermore, capital gains on properties held by the SMSF are assessed at a discounted rate.
What are the challenges and downsides of borrowing through an SMSF?
While there are huge benefits to borrowing through an SMSF, there are also some major downsides.
Managing an SMSF takes a lot of time and effort.
Getting an SMSF up and running is already tedious and adding a property investment will only make matters more complicated. While the fund can hire professionals to get things done, the responsibility of making sure everything meets compliance standards ultimately falls under the trustees’ shoulders.
Also read: Seven-step guide to using SMSF in property investing
Costs could potentially be higher.
SMSF Loans are charged with higher interest rates than regular home loans.
Properties cannot be improved using borrowed funds.
While SMSF loans can be used to repair and maintain the property, they cannot be used to make additions to the property, like building a granny flat or extending rooms.
There are heightened risks when investing through an SMSF.
SMSF is considered riskier given the compliance requirements needed to securely carry out property investments.
Getting an SMSF loan is limited to a few lenders.
Given the risks associated with SMSF loans on the side of the banks, many lenders, including the big four banks, have decided to cease offering such to borrowers.
Frequently Asked Questions
Yourmortgage.com.au's answers to the most frequently asked questions in SMSF
Just like any superannuation fund, an SMSF can be used to invest and save for your retirement. Any profits generated over the life of the SMSF can be accessed once you reach the appropriate age.
SMSF is a "do-it-yourself" super and setting it up involves assembling your team, appointing your trustees, obtaining a trust deed, registering with the Australian Tax Office, opening a dedicated bank account, and investing in assets that could help generate profits for your retirement.
No, Australian Retirement Trust is an industry fund, which is open to the public and is managed by an established trust. SMSF works like an industry fund where the profits generated are for the retirement of the members - the difference, however, is SMSF is a private fund that is managed by the members themselves.
How much you can borrow with your SMSF depends on the structure and type of investments, but for residential assets, you can borrow around 65% to 80% of their value.
Yes, you can live in the property previously named under your SMSF provided that you have already reached the preservation (retirement) age, which would legally allow you to access your superannuation.
Furthermore, the property must have passed the "sole purpose test" when it was held under your SMSF. This means that any proceeds generated from the property must be for the benefit of the members of the fund.
Moving into the property purchased by your SMSF means that you will be selling the property and transferring the property under your name. You will have to check first whether you can do so without having to pay for stamp duty. Check with your state/territory laws to see the rules surrounding the "in-specie" transfer.
A self-managed superannuation fund (SMSF) is a type of superannuation fund that you manage yourself, meaning you have control of the investments the funds make and any profits generated will be for you and the other members retirement.
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