Investing in bricks and mortar

Buying property can provide a boost to DIY funds' asset pools but it's wise to consider the pitfalls, too.

Property is on the radar for trustees of self-managed superannuation funds. So far, the number of SMSFs that have invested in residential property since the borrowing rules for super funds changed in 2007 has been small but now trustees are starting to look around for alternatives to their low-yielding cash holdings.

Last month, the mortgage insurer Genworth published the results of a mortgage market sentiment survey, which showed that 53 per cent of SMSF trustees ''found residential property an attractive investment''.

A senior adviser at Centric Wealth, Gary Marsh, says he has set up a couple of loans for clients in the past year. In both cases the clients were professionals who used the borrowed funds to buy their practice premises.

TAX BENEFITS

Part of the appeal of property investment for SMSF trustees is that they can buy the premises in which they operate a business.

The normal rule is that super funds cannot buy assets from related parties but there is an exception when it comes to the business premises of a member.

Marsh says one of the positives of investment in property through a self-managed fund is that you are contributing concessional amounts to the fund to repay the debt.

In other words, the money that is paying off a property loan in a super fund has only been taxed at the 15 per cent contribution rate, compared with money taxed at the marginal income tax rate outside super.

Marsh says another positive is that if you retire and convert the super account to a pension, you can sell the property without having to pay any capital gains tax.

Property investment makes up a surprisingly small part of the SMSF asset pool. About 11 per cent of total SMSF assets are invested in commercial property and only about 5 per cent in residential, according to the Australian Taxation Office. Shares make up 32.2 per cent of the average SMSF assets allocations, and cash and term deposits account for 27.9 per cent.

A 2007 amendment to the Superannuation Industry Supervision Act established the right of super funds to borrow to invest in any asset that they would otherwise be allowed to buy outright. The rules say borrowed funds can only be used to acquire ''a single acquirable asset''.

This idea of a single acquirable asset creates potential problems for SMSF trustees who want to gear into property.

The head of technical services at MLC, Gemma Dale, says: ''If the super fund uses borrowed funds to acquire vacant land, the land is the single acquirable asset. If you put a building on it you have to treat that as another asset. The rules do not allow for a single loan to fund two assets.''

So the single acquirable asset rule knocks out any deals where the trustees are planning to do property development.

OTHER TRAPS

Renovations also present a problem, Dale says. Improvement to real property is defined as a replacement and may not be permitted.

This is a confusing area because of the uncertainty about what is improvement and what is maintenance.

''Regular capital improvements are required to keep properties commercially viable,'' Dale says. ''This prohibition makes the whole proposition potentially unattractive.''

A super fund making a claim for damaged property after a flood or storm would be able to use the insurance payout to rebuild the dwelling but not to replace it with a substantially upgraded one.

In a recent ruling, the ATO provided the example of a house destroyed by fire. Rebuilding a broadly comparable house is not an improvement as it restores the asset to what it was before the fire. However, if superior materials, fittings and appliances are used, it is a question of degree as to whether the changes significantly improve the state of the asset.

If the house is replaced by three strata-title units, the ATO would consider those as new assets.

According to the ATO, the term ''repair'' ordinarily means remedying or making good defects, damage to or deterioration of the property. A repair restores the function of the asset without changing its character.

An asset is improved if the state or function of the asset is significantly changed for the better through substantial alterations or the addition of further substantial features.

Examples of what the ATO considers improvements include an extension to a house, the addition of a pergola or pool, or installing a home automation system.

PROPERTY IN AN SMSF PORTFOLIO

■ Super funds can borrow to acquire any asset that they would otherwise be able to buy outright.

■ Property holdings must be a ''single acquirable asset'', which means no subdivisions, no development sites and no substantial upgrading of an established property.

■ Self-managed fund trustees can acquire the buildings in which members operate their business.

The story Investing in bricks and mortar first appeared on The Sydney Morning Herald.

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