SMSFs can be complex beasts, so it’s no surprise that the rules around them for purchasing land and buildings are the same.
If you are looking for investment options for your SMSF, you might think that building a house is a solid strategy. Find out if it can be done here, what to consider before, and some alternative options.
What’s in this article:
Looking to take control of your retirement? This table below shows SMSF loans with some of the most competitive interest rates in the market.
Can an SMSF buy land?
Yes, an SMSF is allowed to buy land, provided it is vacant land. The Australian Tax Office considers land vacant if:
It does not contain a substantial and permanent structure
It contains a substantial and permanent structure for residential purposes that was built when you owned the land and is not legally permitted to be inhabited or made available for rent.
Unless you are using your own money, you will need to borrow money to purchase the land, as you usually cannot use the money in your fund. This is because it is difficult to prove that using the money to purchase the land is in the member’s best interests of retirement and it can be difficult to prove that you are working at arm’s length.
To get a loan as an SMSF, you need something called a Limited Recourse Loan Agreement (LRBA). This acts as a kind of protection for your fund, where in the event that you can no longer repay the loan, the lender is limited in their recourse to recover assets to get their money back. A separate trust and trustee, known as the custodian, is created, essentially providing your SMSF with a safety net, preventing the lender from repossessing all of the fund’s assets and instead suing what is in the fund. the LRBA if you are unable to repay the loan.
The important thing to note about using an LRBA is that you can only buy a ‘single acquired asset’, which is a complicated way of saying that you can only buy one thing, not various. Keep this in mind as it is important on the track.
Can an SMSF buy land and build?
An SMSF cannot buy land and build due to LRBA rules. As mentioned earlier, when an SMSF borrows money, it can only buy a single acquiring asset or a single security. If you buy land and build on it, that counts as multiple titles, which is prohibited. In addition, it is no longer considered vacant land. In fact, when buying land and a building, you will need to use a construction loan. Construction loans work very differently from normal home loans in that the loan is broken down into stages depending on the construction process. ATO considers the purchase of the land and this construction process as separate titles.
The rules for LRBAs and SMSFs prevent you from using borrowed money to improve a single acquirable asset. This means that you cannot use borrowed funds to build a property, make repairs, change the nature or character of a house (like turning a four bedroom house into a three bedroom house), demolish a house, and build a new one. or rezone the land.
You might be wondering why these complex rules exist. There is one element of risk in home loans that financial institutions accept and that is how they make their money. LRBAs are already considered higher risk by lenders because they are limited in options for recovering money in the event of default. If an SMSF were to build on vacant land they bought, that would fundamentally change the asset, which is the collateral for the loan. In the eyes of the lender, this increases the risk of default because the borrower takes more risk in doing this. Additionally, if the lender were to seize the asset – the land, which is now fundamentally different with a house half built on it – it will be more difficult for the lender to offload it and recoup its losses.
What are the alternative options?
If for some reason an SMSF is desperate to buy land and build a property, there is some loophole in the restrictions. An SMSF is allowed to buy an off-plan apartment because the purchase contract for the land on which it is built and the building are all integrated into one contract. Also, you wouldn’t typically use a construction loan to buy off plan, but rather a regular home loan.
As for other alternative options, SMSFs are able to purchase established properties using an LRBA. Typically, lenders will require you to have at least a 20% deposit for the purchase of residential properties and in some cases a 30% deposit for the purchase of commercial property. Lenders need to reduce the risk profile when lending to SMSF hence the higher deposit requirement, and this also helps you avoid paying Lender Mortgage Insurance (LMI).
What to consider before buying land with your SMSF
If you are planning to buy land with your SMSF, there are a few things to consider beforehand. It is essential that you review your SMSF’s trust deed to ensure that the purchase of the land is authorized and in the best interests of your trustee’s retirement. If the purchase passes this test, consider asking yourself the following questions:
Will the land generate income for SMSF and if so, how much?
Is income from land better than a less risky investment or savings account?
Will the land increase in value and if so, by how much?
Have you taken into account the costs that the land will incur, such as property taxes and council rates? How much will it cost the fund?
Do the revenues outweigh the costs? If not, how long will it take to generate profit, if at all?
How would the land be treated if a member died or if the fund had to be closed?
Photo by George Pastushok on Unsplash
The entire market was not taken into account in the selection of the above products. Instead, a smaller part of the market has been envisioned, which includes the retail products of at least the Big Four Banks, the Top 10 Customer-Owned Institutions and Australia’s largest non-banks:
Products from some vendors may not be available in all states. To be taken into account, the product and the price must be clearly published on the website of the supplier of the product.
In the interest of full disclosure, Savings.com.au, Performance Drive, and Loans.com.au are part of the Firstmac group of companies. To learn more about how Savings.com.au handles potential conflicts of interest, as well as how we are paid, please click on the links on the website.
*Comparison rate is based on a loan of $ 150,000 over 25 years. Please note that the comparison rate only applies to the examples given. Different loan amounts and terms will result in different comparison rates. Costs such as draw charges and cost savings such as fee waivers are not included in the comparison rate but can influence the cost of the loan.Source link