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The 10 Common Mistakes When Buying Property Through SMSF

Self Managed Superannuation Funds, also known as SMSF’s, have gained increasing popularity among those who are looking to invest in property. Using your superannuation funds to buy property gives you access to a myriad of benefits. This includes wealth creation, tax concessions and asset protection.
 
SMSF’s offer flexibility and control over your own investments, but, setting up an SMSF should be done with due diligence. As with any undertaking where a large amount of your hard-earned money is involved. This guide will aid you in your journey into SMSF’s and property investment. Pointing out the common mistakes investors may encounter and offering solutions to make the process as easy as possible.
 
We have compiled these ten (10) common mistakes investors make when buying property via SMSF as a guideline for those who choose to take this path.

 

MISTAKE NUMBER 1

FAILING TO GET SERVICES FROM AN SMSF EXPERT

 
Although SMSF’s have been around for a long time, the ability to borrow money within an SMSF is relatively new. Many people believe that it is a similar process to borrowing money outside of super, this is not the case. It is possible that most of the people you will encounter in the process may not be well-equipped with the protocols and procedures to ensure a successful outcome. The services of a financial consultant specializing in SMSF transactions would prove to be a prudent choice in the long run. They will help avoid wasting time, effort and money by helping you every step of the way in property investment through SMSF.

 

MISTAKE NUMBER 2

MISCALCULATING FUNDING DEMANDS DURING RETIREMENT PERIOD

 
SMSF Trustees must take into consideration the funding demands of the members’ or their respective dependents during retirement. This is the primary purpose of an SMSF investment in the first place. Government regulations are in place requiring fixed amounts to be set aside from the fund in the form of a pension. Known as ‘drawdown’ – ranging from five percent (5%) annually at age 65 to fourteen percent (14%) at age 95. Retirement funding demands must be considered by Trustees in their investment strategies to avoid unpleasant circumstances where assets would have to be sold to meet drawdown obligations.

 

MISTAKE NUMBER 3

SUBSTANTIAL ALTERATION OF THE ORIGINAL ASSET TURNING IT INTO A REPLACEMENT ASSET

 
The ATO allows SMSF Trustees to utilise their SMSF fund’s resources TO improve their existing asset, i.e. their investment property. However, such improvements must not be so extensive that the original asset will be considered as a ‘replacement asset’.
 
ATO presents several examples of what not to do:
 
· Construction of a house on a vacant land lot
 
· Transformation of a house into a commercial unit necessitating the rezoning of the land where the house is built upon
 
· Subdivision of a single-titled land lot into individually-titled smaller plots
 
· Demolition of a house replaced with a three strata title units
 
These examples are not considered improvements, rather, the asset has been sufficiently changed and is considered a replacement asset.
 
Replacement assets are precedents to non-compliance to SMSF guidelines by the ATO and must be prevented at all costs.

restoration, renovation, change, house and land, investment property

 

MISTAKE NUMBER 4

NON-COMPLIANCE TO THE GOVERNING RULES BETWEEN IMPROVEMENTS AND MAINTENANCE

 
SMSF Trustees are allowed by the ATO to borrow funds for the repair or maintenance of their asset, but not for improvements. However, there is a certain vagueness between what maintenance projects and improvements are. As per ATO’s draft ruling on the maintenance of an asset, actions must exclusively involve the restoration of an asset to its functional efficiency and to prevent wear and tear of same.
 
Once again, it would be prudent to seek the opinion of an expert before finalising decisions for maintenance and/or improvements.
 

MISTAKE NUMBER 5

POOR IMPLEMENTATION OF RULES ON ‘SINGLE ACQUIRABLE ASSETS’

 
Within an SMSF the property you buy must be deemed a “single acquirable asset.” The latest ATO draft ruling on the determination of single acquirable asset is, in essence, if an asset could not be viewed separately even if the asset is under multiple titles then it is a single acquirable asset.
 
In the same ruling, ATO cites these examples to further illustrate the rules in defining this type of asset:
 
· Two adjacent blocks of land
 
Despite absence of a physical impediment between two adjacent properties, two blocks of land cannot be considered as a single acquirable asset although the blocks of land may be acquired under separate Limited Recourse Borrowing Arrangements (LRBA’s)
 
· A factory complex on more than one title
 
A multi-titled factory complex could be considered a single acquirable asset. The factory adds considerable value to the land and therefore the asset.
 
· Farmland with multiple titles
 
The different parts of the farmland could still be used for varying farming activities. Therefore, it could not be considered as a single acquirable asset.
 
The intricacy of the single acquirable asset clearly requires professional advice to guarantee adherence to ATO rulings.

loan, loan arrangements, documents, contracts, property investment

 

MISTAKE NUMBER 6

IMPROPER SET-UP OF SMSF AND ITS TRUSTS IN LOAN ARRANGEMENTS

 
The ATO clearly defines SMSFs as “special type of trust, set up and maintained for the sole purpose of providing retirement benefits to its members (the beneficiaries).” Trustees’ main task is making sound investment decisions. Therefore, they must make certain any transactions entered into, especially in loan arrangements, are in compliance with any restrictions. An SMSF Loan arrangement could be illustrated summarily in this structure:
 
Below are examples of incorrect or problematic loan arrangements:
 
· The SMSF is the buyer in the deed of sale. This is in breach of the loan arrangement where the security trust is the holding entity, therefore, should act as the buyer.
 
· The security trust has active duties. In the above diagram, it can be ascertained that the security trusts acts as a holding entity for the title deeds of assets. The trust’s actions must be simple and restricted so as to avoid trusts being considered as an ‘active entity’ for tax purposes.
 
· The lender acts as a trustee. Clearly, this conflict of interest may be questionable to the ATO.
 
· The security trust directly initiates the loan arrangement with the lender.
 

MISTAKE NUMBER 7

CONSIDERING SMSF PROPERTY PURCHASES AS ‘REGULAR TRANSACTIONS’

 
Trustees have the primary responsibility of making sound investments to ensure maximum profit for the beneficiaries of the SMSF. Hence, trustees must bear in mind the SMSF’s specific purpose. That is to provide retirement income compliant with superannuation regulations when venturing into an investment or loan arrangement and forego the idea that they are buying as ‘private citizens’.

 

MISTAKE NUMBER 8

INSUFFICIENT KNOWLEDGE OF LENDING REQUIREMENTS

 
SMSFs are allowed to enter into loans with either a bank or other lending institution through LRBA’s (limited recourse borrowing arrangement). It is typically stipulated though that the option of the lender will be limited to the financed asset in order to protect trustees from personal liability. It is implicit that this kind of arrangement would cause the lenders to practice due diligence measures to minimize their risks. Knowing all of these, the trustees must be thorough in reviewing and preparing lender requirements at each stage of the process to guarantee obtaining the funds.

home, house, retirement, investment, super annuation

MISTAKE NUMBER 9

PURCHASING PROPERTY WHEN SMSF IS NOT YET FINALISED

 
If you are aiming for a comfortable and worry-free retirement, an effective investment strategy should include the purchase of a property complementary to the goals of your SMSF. It is not possible to purchase a property before your SMSF is set up and then have it transferred into the fund. Securing an SMSF prior to any asset investments increases one’s chances in buying a property the value of which is adequate to your available funds.

 

MISTAKE NUMBER 10

NON – COMPLIANCE TO RULES ON RELATIONSHIPS WITH RELATED PARTIES

 
The primary purpose of the SMSF to provide benefits for its members during retirement cannot be stressed enough. A common mistake in the administration of an SMSF is that the funds are invested for serving the short-term interest of the members instead of its goal of supplying the financial needs of the members upon their retirement. The ATO is implicit in its ruling about what trustees are restricted from in dealing with related parties:
 
“Lend to, invest in or lease to a related party of the fund, more than 5% of the fund’s total assets”

 home, house, super funds, investment

CONCLUSION

 
This guide was written with the intent of helping people avoid the costly mistakes in their venture into SMSFs as listed in these pages. Although the brevity of the guidelines presented here may not give you the complete details of SMSF investment. It is our hope that you will consider the important issues raised here in strategising your financial future and realise that professional help is available to assist you every step of the way. In the event you don’t already have a financial planner our network is available to assist. Good luck and happy investing.
 
“Tell me and I forget, teach me and I may remember, involve me and I learn.” – Benjamin Franklin

Finance Options and Management

Put Your Property To Work

You can enjoy another perk from property investment by making good use of your residential property’s equity. This is the difference between the value of your property and what you owe. Let’s say your property is valued at $500,000 and you have $200,000 left to fully pay the property. Then your equity value is at $300,000. Lenders will allow you to borrow against the $300,000 to manage your funds, invest, renovate or even refinance your mortgage.

Homeowners may refinance their existing property at the current higher value without having to sell the property. You can use this option instead of waiting for years to save up for a deposit. It will allow you an opportunity to capitalize on the current market value of the intended property. It must be taken into account that using equity means your mortgage payments will increase. Also, that the interest for the new loan will be paid at your mortgage rate. You have to seek for professional advice which is highly encouraged.

Managing Your Commitments

The success of your property investment depends on meeting your financial obligations. Financial management is so much more than just bagging the cheapest home loan rate. It’s about your overall financial position. This includes a full understanding of your commitments and watching your spending habits.
 
You have to review your debt profile. This is composed of your credit card balances, store cards, purchases and the like. These types of debt rack up high-interest rates significantly affecting your cash flow.

Your borrowing capacity could be greatly affected by how much you owe in unsecured debt. This often causes investors to hold back their plans in growing their portfolio. Lenders also evaluate the “serviceability” of a loan applicant based on their paying capability.

It maybe that a good portion of your monthly income goes to high-interest payments. If this is the case, it could limit the amount of money that you may be able to acquire property. Your debt can be reduced by controlling your spending as much as possible. This is to help pay off your debt or at the very least improve your standard of living.

 

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Understanding the Market and your Tax Position

How’s The Market?

Sound market research is important. A major return for your property investment is maximized when you base your purchasing decisions on it.
 
The internet has become the handiest and most reliable research tool today. Information on your area of interest is available at your fingertips. Thanks to a foray of online listing sites you can choose from. Here, you instantly get the feel of the market and check the following:
 
  • – The prices of properties in your chosen locality
  • – Availability of properties
  • – Average asking price.
 
Of course, there’s nothing compared to an actual site visit. Photos posted on a property listing site or in the promotional materials might be very different than the actual house itself.
 
You should also consider the demand for rental properties in your chosen area. This is to determine how fast you can find tenants and avoid long periods of vacancies. It is also very important when your mortgage is dependent on your rental income. In this case, it would be wise to contact local agents and inquire which properties are renting fast.

tax position market understand property investment

What’s Your Tax Position?

As a safe and reliable investment, property investment could help you improve your overall tax position.

Investors’ ability to borrow is a considerable portion of the property value. They also enjoy tax benefits based on the financing structure of their property. The type of property and estimated income affects this as well. The owner is taxed on the income if the investment returns a profit. If a loss is declared over the fiscal year, the owner could reduce the taxes he pays through offsetting the loss on other income.

Interests that you can offset against the income from the rental income:

  • – Interest charged on depreciation
  • – Insurance
  • – Investment loan
  • – Overheads or other similar costs

When an investment property incurs a net loss and this is offset against the income, this is referred to as ‘negative gearing’. Investors must be well aware of negatively geared properties due to the size of their deposit. Still, others opt to manage their properties on a loss for tax purposes.

Another to consider is investment properties, when sold for a profit, will sustain Capital Gains Tax (CGT). You should take a note of this when evaluating your property investment plan. As well as the potential profit from a property sale.

It is important to ask for an accountant or a qualified tax adviser’s opinion before venturing into property investment.

 

Previous Article: What’s Your Buying Strategy?

Next on the blog: Finance Options and Management

What’s Your Buying Strategy?

Now that you’ve set your financial goals, have decided your investment strategy, and received your pre-approval from a lender, where do you go from here?

Another important factor you have to establish is your buying strategy. If only for the purpose of avoiding investing into a property that is not only to your liking but also not fit to your investment plans.

In your search for the property of your choice, you must first consider if you’re looking to buy a low maintenance investment or a fixer-upper.

There are both potential value and drawbacks in purchasing a property in need of renovation. The cost and management of which could prove to be difficult if you’re not much of a hands-on-person, requiring you to bring in additional manpower to do the work. On the other hand, new and pristine properties are still high-priced even if they have the tendency to rent instantly.

property investment buying strategy

The location of your prospective investment is another important factor to consider. There is noteworthy market price differences in property in varying states. Some investors are attracted to investment opportunities outside their own locale. For instance, A Victorian 3-bedroom house may cost half as much as a similar residence in Sydney.

Investors on a restricted budget may consider hunting properties in cheaper areas. The only risk is that you may need to rely on agents you have never met before and on a property manager to take care of landlord duties.

After geography, the next thing you have to consider is what type of property you want to have. Generally, land value increases the closer it is to the city. This could mean that investors would prefer for a unit than a land with improvements. Recently, units have become the prudent choice for Australians who wish to live close to the city. This means that rental returns as well as capital growth are looking positive.

What’s important in property investment is you do your homework and review the location carefully. Consider proximity to schools, shops and other amenities which increases its appeal to potential tenants or buyers.

What’s Your Borrowing Capacity?

To maximize their success in property investment, investors must analyze first and foremost their financial position and borrowing capacity. You need to already establish your financial goal. The natural next step is to determine what kind of financing is needed to facilitate the purchase of the property of your choice. Financing of course refers to your borrowing capacity. Therefore your payment capabilities as taking on debt greatly influences your investment strategy timetable.

For first home buyers, farm buyers and vacant land owners, they are entitled to some tax exemptions. They should check with the local revenue office of these entitlements which is a factor for your borrowing capacity. Residential property asset is an alluring investment indeed. It allows the investor to borrow a significant amount to fund the purchase.

Property prices usually ranging in the hundreds of thousands of dollars. Property purchase might prove to be a daunting task for most of us. Due to it being a stable investment, financial institutions are quite lenient and flexible to granting home loans of up to 80% of the market value price.

The first thing to consider among your financing options is to hire a mortgage broker. They can assist you in evaluating how much should be borrowed for the purchase after selecting the mortgage. This is of vital importance since mortgage brokers can help you determine how much you can afford to borrow and not go beyond that.

Due diligence dictates that consulting an accountant prior to any loan applications is necessary. There are also other factors you need to consider. Such as tapping into a home equity loan if you are already a current home owner especially when your property’s value has already appreciated considerably. That equity could be used as a down payment for a new investment.

But if you are a first time investor, the usual stumbling block is coming up with the deposit.

borrowing lending credit loan

It is still possible to borrow a large amount of the purchase price. However, you may need to be in possession of some savings. If this is the case, the good news is that Lenders Mortgage Insurance (LMI) allows you to borrow up to 95% of the market value of the property. LMI protects lenders against losses in case a borrower defaults on a home loan. If it is necessary for the security deposit to be sold after the default and the sale price will not cover the unpaid balance of the loan. The lender may apply for an insurance claim for the reimbursement of the loss. The cost of LMI might be a little steep but borrowers may include it in the amount to be borrowed, in effect lessening costs for the buyer.

Another option for first time buyers is the use of a guarantor to back up the loan. Essentially, the guarantor partly shoulders the responsibility of the purchase. Usually by providing a deposit for first time buyers who have sufficient funding for a loan but not enough for a deposit. Both the borrower and the guarantor must have a full grasp of their responsibilities before engaging in any commitment.

Ultimately, what determines how much funding you should borrow is your capacity to pay monthly on your mortgage.

This is what greatly influences the lender’s evaluation of your loan application. Lenders would inform you of your maximum borrowing capacity. But you must be aware of the actual amount you’re comfortable with.

The first step is to analyze how much disposable income you can afford on a monthly basis. There might be a difference between your net rent income from your property and the amount you need for your monthly mortgage. Thereafter, you should discuss this with your broker of choice. This is to design a strategy for you based on your estimates. Offers from different lenders against your financial goals and lifestyle choices to give you an overall idea how much you can afford to borrow.