For some time now, there has been speculation as to whether or not there will be limitations placed on the borrowing capacities of SMSFs.
According to industry insiders, this has resulted in an, often ill-advised, rush to borrow funds and purchase property.
Experts are warning that parties who are feeling pressured to make investments in an attempt to pre-empt regulation changes may not be taking enough time to weigh up their options and do research.
One of the biggest advantages to being a member of an SMSF is the option of borrowing funds to purchase property. SMSFs are able to borrow money through what is known as a limited recourse borrowing arrangement (LRBA), meaning that the debt liability is directly linked to the associated asset. The option to borrow funds offers some especially attractive advantages to small business owners.
Small business owners are able to purchase their business premises with their SMSF (under certain circumstances) with generous tax concessions. The decision to purchase a business property in an SMSF is doubly complex: it needs to serve the interests of the business and the super fund. As such, experts are warning against SMSFs rushing into purchasing a business property based on concerns over changes to regulations.
A possible alternative to using an LRBA to purchase property in an SMSF is via a unit trust.
One of the main reasons that owning property in an SMSF is so attractive to investors is its tangibility: there is something comforting about being able to see and feel where your retirement savings are invested. Furthermore, many Australians feel more confident in their knowledge of the property market, as opposed to other types of investments such as shares.
However, these comforts can blind people to the real question: is property a good investment?
If so, there are other avenues into property investment that don’t require taking on an LRBA, namely unit trusts.
Unit trusts are an investment structure that allows investors to pool their cash in order to increase the asset classes that are available to them and potential for diversification. Ownership is structured through ‘units’ and returns are distributed evenly between each unit. Unit trusts do not pay tax because the returns are distributed to the unit holders, who then pay tax at their marginal rate. Superannuation funds pay tax at the low, flat rate of 15%.
In some circumstances, it is also possible for unit trusts to borrow funds to increase their investment leverage. Unit trusts that are able to borrow are called geared unit trusts. Super funds can invest in geared unit trusts provided that a number of specifications are met. For example, no other investors can be related to the fund members and no single investor may own more than 50% of the units. SMSF trustees who are interested in investing investing in a geared unit trust are strongly advised to seek professional advice, as compliance in this area is complex.
Ungeared unit trusts are generally used where the SMSF investor wants to form a unit trust with a related party. Ungeared unit trusts are commonly used to purchase a business premises owned by a fund member, and the trust will then lease the property back to the business. This is an option that is worth investigating for SMSF members who are concerned about potential regulation changes.