An SMSF should be thought of as an investment vehicle with a very specific purpose – when it comes to the property investment mistakes covered in this article, often the root causes are due to an SMSF transaction being treated as if it were a normal property transaction.
This shouldn’t diminish the fact that borrowing to purchase an investment property in an SMSF is one of the more complex investment strategies available to investors.
There are numerous separate stages and distinct steps that need to be executed correctly and in the right sequence. Unless you have completed a number of property investments in your SMSF, mistakes can occur.
Don’t be discouraged – for serious property investors, SMSF can be a great long-term investment tool.
Being informed of the mistakes that can hinder an SMSF property investment can help you ensure the advice you receive is accurate and compliant – Even if you are engaging professionals to manage your property investment process, remain diligent, as it is your money and your retirement that’s at stake.
#1 Failing to consider your investment and risk strategy
You may already be aware of the requirement of SMSF Trustees to prepare an investment strategy (Number #7 in this article). Even if you satisfying this requirement, there are mistakes that can occur:
- If you have a low superannuation balance – A property investment could leave your SMSF inadequately diversified, exposing your portfolio to unnecessary risk or violating your investment strategy.
- If you are nearing retirement (within 10 years) – A short time frame may not provide enough time to realise negative gearing gains.
- If you are not a hands-on investor – Or if you’re exceptionally risk adverse, controlling and managing the investments within a SMSF may be overwhelming, if you are unsure, seeking advice is highly recommended.
- If you are not receiving good tax advice – You are required to pay tax on investment income earned in SMSF, ensuring your portfolio is structured tax efficiently can mean more investment income is retained by your fund.
#2 Transferring ownership of property before all arrangements are in place
The entity that will be legally acquiring the property investment must already exist before the contract is signed, failure to do so can be an expensive mistake:
- If the property is purchased in the wrong name (individual rather than the Fund) it can result in a non-compliant purchase.
- If you change the name of the entity purchasing the property you can pay stamp duty twice (e.g. Purchase in a personal name, then transferred to a corporate trustee).
- If you already have an SMSF in place, it may cause delays because your current Trust Deed does not allow for borrowing and requires updating.
- Without an investment strategy in place, it may result in an emotive purchase rather than a strategic purchase.
#3 Setting up the SMSF and/or related trust(s) incorrectly
There are a number of additional entities involved in an SMSF property purchase when compared to an average property purchase. Ensuring the correct structure of your SMSF is vital to the successful completion of the property purchase.
The differences in investment structures…
Mistakes commonly occur during completion of documentation:
- If borrowed money is required to purchase a property, the Sales Contract must be in the name of the Corporate Trustee (for the Bare Trust) as Trustee for the SMSF.
- If borrowed money is required to purchase a property, the Loan Contract must be in the name of the Corporate Trustee (for the SMSF) as Trustee for the SMSF.
- If the property is purchased directly, the Sales Contract must be in the name of the Corporate Trustee (for the SMSF) as Trustee for the SMSF.
Note: while a Corporate Trustee for the SMSF is not a mandatory requirement, should circumstances change with the members of the SMSF, changes to Trust Deeds and Asset / Trust ownership is simplified.
Small oversights on documentation can lead to non-compliance, complex rework and the potential for additional costs being incurred.
#4 Buying a property with more than one title
The Single Acquirable Asset Rule applies to limited recourse borrowing arrangements and stipulates that the loan applies to a single asset only:
- If the property has multiple title deeds, even if it is sold as a single entity, it can result in your property purchase not completing. This can rule out the purchase of house and land, construction or property with development potential and multi-residential developments.
- Where a property is sold fully furnished and the contract for sale states the whole (property and furniture) as being in multiple assets, it can result in your property purchase not completing.
- Where a property investment includes a car parking space located on a separate lot, this may be considered separate assets unless there is a legal restriction on selling the space separately, which can result in your property purchase not completing.
This is a complex legal requirement that continues to catch out unsuspecting investors, though generally, a good measure is whether the asset is able to be split upon a further sale.
#5 Purchasing from a related party
You cannot intentionally acquire an asset from a related party of the SMSF unless an exception applies (as in the case of commercial property). A related party can include a child, parent, grandparent, sibling, aunt, uncle, great-uncle, niece, former spouses, all members of your fund and associates, and all standard employer-sponsors of your fund and their associates.
Failure to adhere is a violation of ‘arms-length’ arrangements.
Arm’s Length Arrangements: All SMSF investments should be maintained on a strict commercial basis and the assets in the fund should always reflect the true market value for the asset.
#6 Borrowing to purchase a renovator
Superannuation legislation allows SMSF trustees to borrow funds for the maintenance or repair of assets. This provision does not extend, however, to allow SMSF’s to borrow funds to improve assets.
Renovations which merely return the asset or component of an asset back to new condition are classified as repairs for the purposes of the superannuation borrowing legislation… Mistakes occur when changes are made in the course of repairs e.g. extending bench space or removing non-load bearing walls.
#7 Breeching the rules on ‘improvements’ and ‘replacement assets’
SMSF trustees can use their existing fund resources (NOT borrowed funds, see above) to improve assets.
The mistake is made when such improvements are so comprehensive that it creates an asset that is substantially different from the original, such as a residential property that is converted into a place of business. A resulting asset where the character of the original asset has substantially changed is called a ‘replacement asset’.
Should this occur, the property could no longer continue to be held under the borrowing arrangement – as it would not be recognised as the asset originally acquired by the SMSF (via the holding trust).
#8 Not properly researching loan options
Not understanding lending requirements can slow down the process of securing finance or leave you short on borrowing capacity to satisfy your investment:
- If you fail to satisfy the strict ‘limited recourse’ borrowing criteria your property settlement may not complete (borrowing requirements differ markedly from standard mortgage products).
- If you fail to shop around you may miss out on the most appropriate loan for your SMSF, needs which can benefit you through lower interest rates or increased borrowing capacity
- If you are borrowing from a related party on more (or less) favourable terms you will be violating ‘arms-length’ arrangements
The SIS Act does not prohibit the SMSF borrowing from a related party however, this cannot be done on more or less favourable terms than what is available with an independent third party.
For more information, see this article on Borrowing within an SMSF: The 3 Major Difference to your typical home mortgage
#9 Neglecting to properly manage the trust
As the holder of the legal ownership of the asset, the trust needs to be managed to a standard that complies with SMSF regulations. This requires Trustees to have tax returns and financial statements of the fund audited annually.
You should be aware that Self-Managed Superannuation Funds (SMSF’s) are anything but self-managed. This concept can be misleading as both an accountant and SMSF auditor are required to support your ongoing obligations as a Trustee.
For more information on obligations, see the article: 6 ongoing responsibilities of SMSF trustees and the 8 compliance penalties they help avoid [coming soon].
There you have our 9 SMSF mistakes that can ruin your property investment efforts…
Specialist advice for all investment asset classes, lending structures, trusts, and complex super strategies can be difficult to come by, and often investors are unaware of the services and advice they should be receiving, but are not!
If you are considering taking control of your superannuation, then you should be well informed of the mistakes that can occur during the establishment and purchasing stages.