Once you’ve decided setting up a self-managed super fund (SMSF) is the right decision for your future, it’s important to understand the steps involved in getting your SMSF established. I’ve taken a bit of time to outline five key steps below (which, ideally, your accountant will coordinate for you).
It is worth noting that setting up an SMSF takes time and can be costly. However, depending on your circumstances, buying commercial property through your SMSF can be a great way to grow your wealth, especially if you have a business.
Five key steps
1. Establish a trust
Before you can register an SMSF with the ATO, you need to establish a trust, which needs to have:
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- Identifiable beneficiaries; and
- Intention to create a trust.
2. Obtain the trust deed
The trust deed sets out the rules and conditions under which the SMSF will operate, so it’s vital it’s a well-drafted document. It should be prepared by a qualified legal practitioner who understands superannuation law, and SMSFs in particular, and be designed to give trustees maximum control and flexibility.
When the trust deed is found to be satisfactory, it should be executed by the trustees according to the rules applicable in their state or territory.
3. Sign a declaration
Upon becoming a trustee or director of an SMSF, you are required to sign a declaration stating you understand your obligations, duties and responsibilities.
The declaration must be in the approved form (available from the ATO) and completed within 21 days of you becoming a trustee.
4. Lodge an election with the regulator
Within 60 days of the establishment of an SMSF, trustees must lodge an election to be regulated with the ATO.
This election is irrevocable and advises the ATO that the SMSF will be subject to the requirements of the relevant superannuation legislation and, therefore, will be entitled to concessional taxation treatment at the rate of 15% as a complying fund.
If an election notice is not lodged, the SMSF will not be treated as a complying fund for taxation purposes, and the SMSF will be taxed at the highest marginal tax rate.
5. Open a cash account
The trustee of an SMSF will generally need to set up a cash account so the fund can accept contributions, rollovers and earnings from investments.
This account will also be required to pay expenses, such as annual supervisory levy, accounting fees, taxation liabilities and, importantly, member benefits.
Now that you, with the aid of your accountant, have completed all of the above five steps, you need to decide what vehicle you wish to invest your money into.
There is a wide range of investment options, such as liquid equities, shares, managed funds and indirect and direct property investments. Additionally, there is plenty you must consider when choosing your investment vehicle, such as stability, liquidity, growth assets versus yielding assets, leverage versus non-leverage, and so on.
This article, however, was written as a guide for those considering utilising their SMSF to invest in direct property.
The next step is deciding what kind of property to buy, how to buy it, and how to get the most from your investment.
Not so simple. Investing in property within your SMSF can present a minefield of pitfalls and you really need to ‘know your onions’ before you commit to a contract.
One of the first questions to ask yourself is whether you’d like to invest in a commercial or residential property. Using your SMSF to purchase a commercial property has some benefits over a residential property, especially if you run a business which can potentially become the tenant of your SMSF investment.
However, this increasingly popular method of maximising wealth carries risk and needs careful consideration.
I’ve put together some of the pros and cons of buying commercial property through your SMSF to help you consider if this investment option is right for your objectives.
Rent the commercial property you invest in
The majority of commercial properties purchased through an SMSF are then leased back to a business operated by an SMSF member.
Notably, 100% of the money in an SMSF can be invested in commercial real estate if a member of the fund runs a business. This can help minimise your business overheads and maximise cashflow long term if done correctly.
A member can also borrow funds to purchase a commercial property through an SMSF — however, the purchased property will only be available to the SMSF fund, meaning you can’t buy a residential property and occupy it or rent it out to a relative. This option, therefore, is great if you are looking to run a business. Don’t think you can get creative and adopt this strategy in an owner-occupier scenario.
Pay rent to yourself, not a landlord
Many investors prefer paying rent to their SMSF, rather than someone else. This is especially true with commercial properties, as commercial rental yields are generally larger than residential yields, so your SMSF can potentially grow quicker.
However, capital gains on commercial property tend not to be as large as a smart residential investment, so if you are playing the long game, with capital growth as your main objective, you really have to consider if this strategy is the correct one for you.
In saying that, tax on rental income is only 15%, and capital gains tax just 10%, if the property is kept for more than a year, so there are some distinct tax advantages to using your SMSF to purchase your business premises.
Remember, there are always risks involved
Despite all the positives involved in investing in commercial properties through your SMSF, there are still some major pitfalls.
For starters, tax losses from the property cannot be offset against your personal income tax, unlike when investing with your personal name or certain trust structures.
There are also a few conditions to be aware of.
- If you lease the property to a business you run, the lease must be at the market rate (or within 5-10%), so don’t think you can charge rent to your business at an exorbitant rate, as the ATO is on the lookout for this.
- You can’t skip a rent cycle. Payments must be made on time and in full, as if you were leasing from a stranger. Again, the ATO is watching for this.
- The property must be independently valued regularly as part of your ongoing SMSF audit process.
- The investment must be for the sole purpose of providing a retirement benefit to the SMSF’s members. Don’t think you can sublet or create a ‘side hustle’ income from the property as you are likely to get pulled up as part of regular audits.
- You also can’t use the property asset as collateral against a future personal or business loan, which is a significant business consideration in the event of a downturn, or if you need to expand or invest.