27/09/2012

A personal self-managed superannuation fund (SMSF) may be the best structure to use for your investments, notwithstanding its limitations.  Borrowing by the super fund could then provide you with the necessary leverage to accelerate your investment returns but care needs to be taken to ensure the level of borrowing is sustainable.

Consider this.  Sean is 35 and doing well at work and wants to invest in real estate for the long term.

He puts $25,000 into an SMSF as the only member. 

The Fund borrows $160,000 from the bank and $40,000 from Sean's dad to buy a small investment property for $225,000. 

The loan repayments are funded by the tenants and if there's a shortfall then by contributions to the fund, the first $25,000 of which is tax deductible for Sean.

Interest payments are deductible to the SMSF.

In 10 years the property has increased in value by $150,000.

The $25,000 super contribution is now worth $175,000. 

There are a number of reasons to invest through a SMSF which borrows some part of the acquisition price of the investment.

To magnify capital appreciation - The $25K that Sean originally contributed leads to an increase in value of $150K.  True it is that Sean may contribute more to cover loan repayments but the amounts are relatively small in comparison to the potential growth

To acquire a capital asset using tax-deductible interest payments and to realise capital profits when the SMSF is in pension phase - The SMSF gets a tax deduction for its interest payments and Sean gets a tax deduction for the concessional contributions he makes to help top up those loan repayments.  If he holds the real estate until he is in pension phase there is no capital gains tax if he sells the property.  Even if he sells it before that, the fund only pays 10% CGT as opposed to Sean's 25%.

To negatively gear within the SMSF - Because the fund only pays tax at 15% many think that negative gearing is inappropriate inside a super fund.  That may well be so in some cases.  But if the property is held for so long that it becomes positively geared then if it is outside super the profit is taxed at the top marginal rate whereas inside super it will only be at 15%.

To transfer value to the fund over and above the contribution limits - A modest contribution leads to a material gain.  Other contributions can similarly be leveraged to maximise gain through other investments provided the selection of investments is careful and prudent.

To acquire property which the member can use as their business premises - An SMSF may acquire a member's 'business real property' thereby freeing up the SMSF capital for use by the member earlier than would be allowed under the super laws.

To hold the property in a vehicle which is quarantined against the member's creditors - Generally a member's creditors cannot access their superannuation to pay their debts or liabilities.  If Sean held the property in his own name it would be available to his creditors, but normally not so inside his super fund.  This could be particularly useful for professionals in high risk professions like medicine, accountancy, architecture and, dare we say it, law.

Borrowing by a super fund is complex and you should contact us early in the process so we can help to ensure the transaction is trouble-free.  No decision to set up a personal super fund and or borrow in the fund should be made until you have discussed it in detail with your financial adviser.

If you have any questions in relation to this article, please contact TOWNSENDS BUSINESS & CORPORATE LAWYERS on (02) 8296 6222.