DIY super issue not relevant
The government has been criticised for rejecting the Murray inquiry's recommendation to prevent self-managed superannuation funds from borrowing to buy property. But the concern is misplaced, because there's so little of it. Banning it would solve a problem that doesn't exist. That's because it's not a good investment strategy, at least for residential property.
Strict governing regulations preclude speculative and high-risk activities. For starters, unlike borrowings in personal names, the regulations require the loans to be issued on a non-recourse basis not backed by personal guarantees. This forces financial institutions to demand larger deposits and charge higher interest rates than for personal borrowings, and to assess the viability of the investment, including the cash flow, new contributions and earnings of other assets in the SMSF.
For the investor also, there are serious drawbacks in purchasing residential property in an SMSF. The first is that the rules preclude the use of the property by fund members, their family or associates.
There are no similar restrictions on related-party transactions applying to geared investment in personal names. Indeed, negatively geared transactions can be done to provide tax-subsidised accommodation for children or other relatives with no adverse impact for the investor.
The only way an SMSF investor can legally live in a property owned by the fund is to transfer that property into personal names. This means paying stamp duty and legal costs. Then, negative gearing rules allow investors to move into their property at any time, offering total flexibility without change of ownership.
Another reason SMSFs have only a relatively small investment in geared residential property is the lack of substantial tax benefits. With a negatively geared investment in personal names, the government subsidises losses at the owner's marginal tax rate, usually 34.5 to 49 per cent. In an SMSF, the maximum tax benefit from a loss is 15 per cent, and in retirement pension phase, there's none.
So gearing residential property in a super fund is not tax-effective.
The Murray inquiry was concerned about the increase in SMSF borrowing, but the numbers often do not distinguish between borrowing for residential versus commercial real estate.
An SMSF becomes tax-effective if it is to buy a business property to be used by the owner's business. These are usually higher yielding than residential property and ownership in an SMSF is encouraged by the regulations, allowing business owners to rent properties owned by their SMSF. The rent is tax-deductible for the business and helps pay off the loan. So, this can be more attractive than a negatively geared transaction.