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SMSFs and property: keeping it in the family

Anthony Fensom  |  23 Jul 2019Text size  Decrease  Increase  |  
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The "bank of mum and dad" remains a popular way to get onto Australia's property ladder, but there are considerations for all parties to be aware of, writes Anthony Fensom. 

Home prices in many parts of Australia continue to rank among the least affordable worldwide, leading many people to ask how they can give their children a head start.

Families that invest jointly can build assets for long-term benefit, while other strategies can be used to assist family members in the shorter term – though there are restrictions on SMSF investments.

 

The arm's length test

First, the restrictions: according to the Australian Taxation Office, all investments made by an SMSF must be conducted on a commercial “arm’s length basis.”

Any property acquired must meet the “sole purpose test” of solely providing retirement benefits to fund members; it cannot be acquired from a related party; and it cannot be lived in or rented by a fund member or any related party.

However, families can co-invest to maximise their buying power, says Liam Shorte, director at Verante Financial Planning.

“For families willing to invest together and think longer term, then parents can bring their children into the SMSF and together they can combine their superannuation to invest in a property.

“Over time, as the children’s balances increase and the parents draw down their pensions, the property moves from being majority allocated to the bigger parents’ balances to end up being mostly allocated to the children’s rising balances," Shorte says.

However, while all adult members should be directors of the trustee company and involved in its decision making, Shorte says parents should ensure parties with higher balances also have greater voting rights.

"The voting rights of the members should be weighted according to member balances, allowing them to protect their larger accounts."

SMSFs and business property

A popular strategy is for business owners to acquire their premises via an SMSF, potentially using borrowed funds under what is known as a limited recourse borrowing arrangement.

The property can then be leased back to the business operated by an SMSF member, helping to minimise overheads and maximise cash flow.

“This provides a good income stream for the pension members in retirement and means the children only have to buy the actual business, not the business premises, when their parents exit the business,” Shorte says.

“Later, if balances allow, parents can take lump sum commutations and recontribute to their children’s accounts to ensure the premises stay in the fund longer term, facilitating intergenerational wealth transfer while still alive in a tax-effective manner”.

However, though such investments can provide long-term benefit, they are not a solution for providing a current home for younger family members.

Other considerations related to property acquired under a LRBA include the following:

  • SMSF property loans generally have higher costs versus standard property loans.
  • Any loan repayments must be made from the SMSF, requiring sufficient liquidity in the fund.
  • Any tax losses from the property cannot be offset against taxable income outside the SMSF, and no alterations can be made to the property that could change its character.

Other ways to help kids buy property

Lending money to family members at below-market rates – while being mindful of related-party restrictions on loans from SMSFS – is another potential strategy.

Independent legal advice should be sought by each party before entering into such agreements, to ensure appropriate protections are in place. These measures can include a requirement for income protection on the part of the child in order to guarantee mortgage payments.

Parents can also assist by making a gift or contribution to the child’s SMSF, although such contributions are not tax-deductible.

Another option is acting as a guarantor, although if the child fails to meet his or her obligations, the parent could be held responsible for the shortfall.

“Parents need to consider if the kids are making a good decision and if the kids have sufficient job security and financial responsibility to continue to meet their commitments,” says Brad Hoffman, associate principal at Virtu Super.

“If the relationship between the parents and their kids breaks down, the banks won’t release their obligations."

 

Government policies: pros and cons

An alternative strategy for first home buyers is accessing the first home super saver scheme, which allows such buyers to make voluntary concessional (before tax) and non-concessional (after-tax) super contributions of up to $15,000 per financial year.

Buyers are allowed to save up to $30,000 under the scheme or $60,000 as a couple, providing a tax-effective deposit for a residential property, subject to various restrictions.

The Federal Government has also pledged to introduce a first home buyer scheme, under which buyers with a 5 per cent deposit would benefit from a government guarantee of up to 15 per cent to avoid having to pay lender’s mortgage insurance.

However, the scheme will be capped at 10,000 loans per year, with analysts suggesting only 10 per cent of eligible buyers would be able to access it.

There are also various state government schemes assisting first home buyers, such as the $10,000 first home owner grant in New South Wales or the $20,000 available to such buyers in regional Victoria, among other benefits.

Though property prices have been cooling in Sydney and Melbourne in more recent times, Australia’s biggest cities have been ranked among the world’s most unaffordable for home ownership, according to Demographia.

For parents, giving children a helping hand either inside or outside an SMSF will likely remain popular well into the future.

 

is a Morningstar contributor.

This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria. 

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