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It’s no secret that Australian real estate prices are high. Many younger people cannot afford to buy a house or apartment in major cities. Even older Australians can struggle to find the funds for an investment property. Many Australians have self-managed super funds (SMSFs) and use them for property investment. This can be a good way to increase the value of a self-managed super fund, but it is not without risks.
Can I use my super to buy a house?
You can use a self-managed super fund to buy a house, but the process is subject to regulations. You can’t use your super to buy any house. The house must meet the following criteria:
- It has to pass the “sole purpose test” of being an investment property that will produce retirement benefits for the owner
- The property cannot be acquired through a third party, whether related or not. It must come from the purchaser’s super fund
- The purchaser cannot live on the property. It is an investment property and must be rented
The property cannot be rented to a fund member or a relative of a fund member
These rules are in place to ensure the investment property is used to increase the value of the super fund.
Other rules are in place as well. While you can improve the property, you cannot use super funds to make the improvements. Super funds can be used for repairs or general maintenance, but not for significant improvements such as adding a home extension. According to the Australian Taxation Office (ATO):
- Repairs are defined as remedying an existing problem. A repair is done to an existing asset in order to make it functional
- Maintenance is work done to prevent an asset from deteriorating or breaking. As with repairs, maintenance applies to existing assets in the home or apartment
- An improvement is anything that improves an asset for the better. This can be a confusing issue. If a kitchen needs to be renovated, how much can you improve it before “maintenance” becomes an “improvement”?
The difference between repairs and maintenance and improvements must be understood and adhered to. For example, you can restore a kitchen, but a kitchen extension would be considered an improvement. If a roof is damaged by a cyclone, replacing the roof is part of repair and maintenance. If you decide to add a second storey before replacing the roof, that would be an improvement and would not be allowed.
Painting the house exterior and interior are maintenance issues and are allowed under the guidelines. Installing a home automation system is considered an improvement and is not allowed. Adding a pergola is an improvement and is not allowed.
These are important considerations because the ATO can take action if they feel an investment property funded by a self managed super has been improved.
Using super to buy property
Because of the strict regulations regarding using a self-managed super fund, you can use super to buy property, but you need to know about the regulations and possible pitfalls. The rules were relaxed in 2007 and reviewed in 2010. Further regulations were put into place in 2016.
One important rule concerns the type of loan you get. In some cases, getting a zero interest loan could backfire on the purchaser. Zero interest loans are generally given by a third party, perhaps a relative. They are considered “non-arm’s length” loans. Such a loan can attract a 47% interest rate from the ATO. This is due to the Practical Compliance Guidelines (PCG) of 2016.
The guidelines for borrowing are included in the limited recourse borrowing arrangements (LRBA) for SMSF borrowing for investment properties. There are also “Safe Harbour” rules that must be adhered to. In general, a Safe Harbour:
- Follows the interest rate set by the ATO in May of each year. In 2015/2016, it was 5.75%
- Fixed loans can only be for a period of 5 years
- The term of the loan can only be for 15 years
- The Loan to Market Value (LMV) ratio can be 70%
- A registered mortgage is required
- Payments must include principal and interest and must be paid monthly
- The loan agreement must be in writing and executed
MoneySmart goes into more details about how to use SMSFs to purchase an investment property. The most important thing to remember is to adhere to the strict guidelines.
Using super for a house deposit
Most self-managed super funds won’t cover the cost of buying a house. Remember the regulations for using SMSFs for a house deposit are strict. It may be a good idea to get professional help before using self-managed super for property investment. A professional will know what you have to do to comply with the regulations.
Also be aware of other costs involved in buying an investment property. These include:
- Upfront fees
- Legal fees
- Advice fees
- Stamp duty
- Property management fees
- Bank fees
Together, these fees will reduce the amount you have for a deposit on a property investment. Also be aware of the home loan conditions for purchasing an investment property. How to compare home loan rates for investment properties points out that while you can borrow up to 95% for your own home, loans for investment properties are generally only for 80% of the home’s value.
Also be aware of the risks of using your self-managed super for property investment. Some of these include:
- Higher costs compared to borrowing for a home you will live in
- Cash flow: your repayments will come out of your super fund. You must have sufficient liquidity to meet the payments
- Loans made on SMSFs can be hard to cancel
- There could be possible tax losses. Any tax losses cannot be offset against your taxable income outside your super fund
- Remember that alterations to the property are not allowed
Are the risks worth the investment? That depends on your personal circumstances. This is a general guide and does not go into all the details of using an SMSF for property investment. Take a hard look at your super funds and get advice from experts in the field. Using self-managed super for property investment can be a good way to increase your super fund or it can be a disaster.
You will also need to do more homework to find a suitable investment property. 11 tips for what to look for in an investment property is a good starting point for finding the right property. Also read 20 tips for financing investment properties for more tips, including tips on finding the right location for a property investment.
You can purchase a “fixer-upper,” but you can only do necessary repairs and maintenance. You cannot improve the property in any way. This may be the best way to increase your rental income without overspending. A fresh coat of paint, yard maintenance and a new fence (if needed) are good ways to increase rents without overspending.
Depending on your circumstances, using a self-managed super for property investment could be the best move you ever make. Study everything related to using your SMSF and finding a suitable investment property before you make your decision. Invest wisely and your investment property can be the best purchase you can make.