Six ways to purchase property using your super
Once you have seen some of my other articles you are likely to recognize that your SMSF is a wonderful vehicle for holding your investment properties. Extremely tax effective along with the maximum possible asset protection.
Outlined in this article I will look at the 6 ways in which your SMSF can buy property:
1. Direct purchase
2. Instalment warrant
3. Tenants in common
4. Joint venture
5. Unit trust
6. Pre-99 unit trust
Direct Purchase:
A direct purchase is precisely that - the SMSF purchases the property directly without the need for intermediary structures or entities set up. For this to take place the SMSF requires to be able to provide for 100% of the purchase price as well as involved costs.
This style of purchase certainly is the simplest way a SMSF can purchase property. No borrowings or gearing is required - meaning the amount of money required is likely to be a lot higher than via other methods. This limits the actual property the SMSF is able to buy and also limits diversification ( in a choice of alternative asset classes or other properties).
A direct purchase will typically be the cheapest in the case of transaction / purchase costs - you don't see any other structures forced to be set up.
Instalment Warrant:
This purchase method requires the title of the property being owned utilizing a simple holding trust (often called a custodian or property trust), with the SMSF concurrently getting a limited recourse loan. The SMSF receives the entire rental income and is liable for all expenses such as loan repayments.
As soon as the loan is repaid the bare trust can transfer the title to the SMSF without having capital gains or stamp duty - provided it's been established correctly.
Tenants in common:
Purchasing is tenants in common enables the SMSF to have ownership of a fixed percentage of a property, with another party ( like an individual or trust) owning the remainder percentage.
This structure doesnt let the title of the property to be utilized as security for gearing - however other party is permitted to use borrowings provided the security is a second property.
It's possible to have even more than two investors each holding a share of the title and sharing the income and expenses if needed.
Joint venture:
A joint venture is when 2 or more parties form a contract to attempt a selected commercial activity and share the outcome of that activity.
By way of example a SMSF as well as a family trust could pool resources / funds to acquire a block of land and construct a house. On completion title is going to be transferred to each jv partner in accordance with their percentage input (i.e. money contributed into the venture) plus it would result in a tenants in common arrangement as described above.
An important thing to remember is the jv partners Must share the results - i.e. the rental income of the completed property Not the sale proceeds from the completed development.
The ATO doesn't like joint ventures involving SMSFs - and rightly so - a whole lot of things can go wrong. Before getting into this kind of arrangement professional advice has to be sort and a proper jv agreement has to be drawn up.
If done properly however a joint venture generally is a valuable tool make it possible for a SMSF to go in the property development arena without entering the business of property development - which can inadvertently lead the trustees of the SMSF to breaching of the laws which cover SMSFs.
A correctly documented jv agreement however can enable a SMSF to get involved with a property development without carrying on a business or breaching the appropriate regulations that affect SMSFs.
Unit Trust:
This structure enables 2 or more parties to secure a fixed percentage of a property through purchasing units in a fixed or unit trust, in which the monies are pooled and utilized to buy the target property.
Just like the tenants in common structure, the actual or target property is incapable of be utilized for security for any borrowings. However other investors ( apart from the SMSF) have the ability to borrow to finance their share of the purchase - provided the aforementioned restriction will not be broken.
A unit trust also can issue different types of units which have different rights. For example there may be units which entitle the unit holder to get a share of any income, along with other units that provide entitlement to capital profits or gains. This may bring advantages when working with segregated investment strategies down the track.
When a unit trust is set up and one party (or group of related investors) will not hold a controlling interest in the trust (i.e. lower than 51%) the unit trust will be capable of utilise borrowings using the underlying property used as security.
As an example four unrelated parties could each invest $100k each into a unit trust, after which obtain another $500k through the bank to allow the purchase of a $900k business property.
Pre-99 Unit Trust:
I will not enter into detail in relation to this purchase method - mainly because most people don't have this kind of structure from greater than ten years ago floating around.
Earlier than 11 August 1999, a unit trust like those described above didn't have the restriction on borrowings. The ATO set up grandfathering rules that enabled such trust to keep precisely the same level (%) of borrowings - however they can't borrow more after 1999.
Another restriction gave such trusts an additional ten years (to 30 June 2009) for them to re-invest their distributions. For example if the unit trust had a profit of $10,000 it may then simply issue 10,000 more units @ $1 each to the unit holder (SMSF) - quite similar way as via utilizing a re-investment strategy with managed funds. For years after 30 June 2009, any distributions paid by such unit trusts need to be paid to the unit holders - they can't be re-invested.
At the time these changes scared many SMSF trustees and their advisers to wind up and close up these pre-99 unit trust set ups. However if used correctly and inside the constraints of the law they were for nearly ten years the sole feasible choice to enable a SMSF to utilize gearing without getting other parties involved.
SMSFs are in possession of a chance to utilise instalment warrants which provides another option for property investment which has a degree of gearing.
Warning: If somebody approaches you saying there is a pre-99 unit trust available your SMSF can invest into after which you can borrow to buy property with no need of an instalment warrant arrangement it is a scam.
Summary:
Buying any property is always a major decision which should not be rushed. The same applies when utilizing your superannuation monies inside your SMSF to purchase a property.
Always make sure you get the proper advice and a structure that is befitting your position - both now and into the future.
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