Westwood Conveyancing

What is the taxation effect on an SMSF investing in Direct Property ?

Buying Direct Property through a SMSF

When a SMSF invest in direct property, the rental income from the property is taxed at 15% in accumulation phase and 0% in pension phase.

On the other hand, if the direct property is held individually, the rental income from the property is taxed at the individual’s MTR.

Case Scenario

• A residential property is purchased for $550,000.
• The rental yield on the property is 3.5%.
• Individual MTR is 37% (excluding medicare levy) - for both case scenarios.

Outcome

By holding the direct property in a SMSF rather than owning the property individually, the tax payable on the rental income from the property will be less.

When the property is sold, the CGT rate is effectively 10% in accumulation phase (on the basis that it has been held for more than 12 months) and 0% in pension phase. On the other hand, any capital gain from the sale of direct property that is held individually will be taxed at the individual’s MTR. A 50% discount on the capital gain will be available provided that the property was held for more than 12 months.

Case Scenario

• A residential property was purchased for $550,000 and sold 10 years later for $775,000.
• Individual MTR is 37%.

Outcome

By holding the direct property in a SMSF rather than owning the property individually, the CGT payable on the sale of the property will be less. In most cases, direct property held within a SMSF will not be redeemed until pension phase where there will be no CGT payable.   

A SMSF will be able to claim tax deductions for property expenses and loan interest repayments.

Having direct property as part of the SMSF’s investment portfolio may increase the fund’s diversification if the SMSF has invested in other asset sectors.

Disadvantages

• Direct property generally has high transaction costs and stamp duty.
• The SMSF Trust Deed and Investment Strategy must allow for the SMSF to invest in direct property.
• Tax deductions are more attractive for direct property that is held individually given the higher tax rate.
• As an investment strategy on its own, direct property will result in a lack of fund diversification as the SMSF will be overly exposed to a single asset.
• If the direct property has residential occupancy by a related party of a SMSF member, it will be considered as an in-house asset and will be subject to the allowable limit of 5% on in-house assets where the market value of the property cannot be more than 5% of the fund’s total assets.
• Direct property is generally regarded as an illiquid asset.
• If the SMSF is in pension phase, the liquidity of the fund may be affected and its ability to pay out the appropriate level of pension.
• If a Limited Recourse Borrowing Arrangement (LRBA) is taken out by a SMSF to facilitate the purchase of direct property, the SMSF will only be the beneficial owner of the direct property until the loan is repaid by the SMSF.

Important Points to Consider

• The purchase of direct property by a SMSF should be carefully considered and form part of the fund’s overall investment strategy and retirement objectives.
• The purchase of direct property by a SMSF can be a good strategy when borrowing is considered as it can be used to increase the fund balance of the SMSF.
• The Risk Profiles of the SMSF members need to be considered to ensure that direct property suits their risk tolerance and income and capital requirements. 

Source  :  We Private

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