Buying property with your super fund has drawbacks

Whether or not the government removes the ability of self-managed super funds (SMSFs) to borrow to purchase property or other investments, the implications for investors are relatively minor. With rare exceptions, borrowing to purchase assets outside super is far simpler and more tax-effective than borrowing in an SMSF.

Even ignoring the strict regulations governing limited recourse borrowing by an SMSF, the maximum tax benefit from deductions including borrowing costs, depreciation allowances and other expenses is the superannuation fund tax rate of 15 per cent. In pension funds there's no tax benefit.

In personal names, the tax benefit ranges from 34.5 per cent to 49 per cent, providing a much larger benefit from borrowing, especially to purchase low-yielding property assets. Complicating matters further for SMSF property purchasers, the regulations prohibit related party transactions except in the case of business rental property.

In practical terms, the restriction on related party use greatly reduces the tenancy options preventing any use of the property by the owners or their children. No such limitations apply to the use of negative-geared personally owned properties which can even be used as a future personal residence by the owner or children. Even after the regulator's tightening of individual investment borrowing, providing the collateral and obtaining a high loan-to-valuation ratio is much easier than borrowing in an SMSF.

The low 15 per cent superannuation tax rate increases the attractions of owning high-yielding assets in super funds instead of in personal names. Property assets generating low current income and steady or even spectacular capital gains are better suited to personal portfolios, especially for longer-term investors.

In superannuation, any capital gains tax rate on gains realised after 12 months is only 10 per cent compared with up to 24.5 per cent on gains realised in personal names. Given that capital gains tax is only payable when assets are sold, this advantage is most significant when assets are purchased and sold regularly. Property investments are generally held for longer periods of time, particularly compared with other assets such as shares. For this reason, as well as the higher annual income including franking credits, borrowing to purchase shares in a super fund can help reduce capital gains tax bills.

Borrowing to purchase investments increases the risk of losses if the investments perform poorly. Investors need to be cautious when contemplating gearing their portfolios. Losses generated in superannuation and pension funds are difficult to recover as are losses in personal names. The one consolation for personal investors is the greater value of carry-forwarded capital losses as an offset to future capital gains.

Considering all the above factors, borrowing in an SMSF has major drawbacks.

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Daryl Dixon

Executive Chairman

Daryl Dixon is one of Australia’s foremost investment experts and a well known writer and consultant. He has provided trusted advice to thousands of personal clients over more than 25 years and is an acknowledged expert in the areas of tax, superannuation (including public sector superannuation), social security and investments.

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