Regardless of whether the government gets rid of SMSF’s ability to borrow funds for property investment or not, the consequences are always negligible for the investor. In fact, it is quite straightforward and tax-effective to borrow outside an SMSF. The rules of borrowing through Self-managed super funds have changed dramatically in the recent past. Though several benefits come along with borrowing with super funds, a couple of challenges are prone to occur.
SMSFs come with strict regulations that govern limited recourse borrowing. Again, the maximum tax benefit one can get from deductions such as depreciation allowances, and borrowing costs is only a superannuation tax rate of 15%. Pension funds don’t come with any tax benefit. Again, in personal names, the tax benefit varies between 34.5-49%. Therefore, it comes with a relatively larger tax benefit from borrowing mainly for those seeking to purchase low-yielding assets. Matters become more complicated to SMSF property buyers because the regulations outlaw any related party relations except for business rentals. The restrictions consequently reduce the number of tenancy options banning any use of the property by owners, their dependents or any other person no matter how related they are. For personally owned properties, no such limitation applies to the use of the property by the owner or even their children for future residential purposes. Even though regulators have tightened their investment borrowing rules, it is still easier to provide a security and obtain a high loan-to-valuation compared to SMSF borrowing.
The relatively low superannuation tax rate of 15% tends to attract borrowers to own high-yielding properties in SMSFs compared to personal names. Personal portfolios like long term investors would better invest in property assets that have steady capital gains and low current income. Any capital tax rate on gains in superannuation after one year is subjected to 10% which is comparatively lower to that of 24.5% in personal names. Capital gains are only paid upon the sale of the property. It is advantageous for the cases where properties are bought and sold on a regular basis.
Moreover, compared to other assets such as share property investments are held for an extended period. Therefore, borrowing to purchase in a super fund can help reduce capital gain tax bills as well as high annual earnings such as franking credits. In case a property performs poorly in the market, borrowing to purchase an asset can dramatically increase potential losses. Property purchased through SMSF cannot be renovated as long as it is still on loan. Only borrowed funds can be utilized for the maintenance of the property but not renovation. Therefore, an investor should never seek renovators delight’ for property in an SMSF fund. Investors seeking to gear their portfolios in SMSF should be cautious about the pitfalls that can occur. It’s hard to recover losses generated through pension funds and superannuation same case to personal names. The only solace for personal names is the value of capital losses that are carried forward to offset any future capital gains.