The top 3 traps of SMSF Borrowing

Using your self-managed superannuation fund (“SMSF”) to invest in residential property is more popular than ever – but don’t sign that contract just yet! SMSF borrowing law is complex and can catch out even experienced investors. Here are the top 3 mistakes we have seen (and fixed!) for clients who have not seen us before signing a contract.

1. Buying the property in the name of the SMSF

Although we talk about the SMSF buying the property, this is technically not correct if there is a bank involved. A separate trust needs to be set up, called a “bare trust” or a “security trust”, which will buy the property and hold it on behalf of the SMSF until the mortgage is paid off. As the bare trust will be the buyer on the contract, it must be set up before signing.

To confuse matters more, the loan from the bank is in the name of the SMSF, not the bare trust!

We see buyers again and again who have already signed a contract in the name of their SMSF. We then need to negotiate with the seller to rescind the contract and sign a new one using the bare trust. This requires the seller’s consent and usually results in the buyer having to pay the seller’s additional legal fees. Re-doing the contract can also cause stress and uncertainty for both sides.

2. Including furniture, gardening equipment, or other goods in the sale

An SMSF is only allowed to borrow to purchase a “single acquirable asset” – in other words, “one thing only”. For residential property, this means that the contract can only include the property and fixtures (such as the oven, washing machine and air-conditioning unit).

Buyers or agents sometimes include items such as furniture, lawnmowers, or pool equipment in the contract. However, these are all separate “things” that cannot be included in the single SMSF borrowing arrangement. These items are usually of minimal value and can be purchased with cash, provided that it is structured correctly in a separate contract.

3. Borrowing from a related party on favourable terms
Sometimes you have the money to buy property, it’s just in the wrong place – outside of your SMSF! In this situation, you can be your own bank by lending to your SMSF, provided that it is properly documented and on arm’s length terms. The loan should be carefully structured to ensure that it meets the ATO guidelines on what they consider to be arm’s length terms.

The penalty for getting this wrong is severe. A non-arm’s length related party loan can taint the entire investment and cause all income to be taxed at penalty rates, defeating the purpose of using your SMSF in the first place. The only way to fix this would be to sell the property and try again!

This is not an exhaustive list of issues that can arise when borrowing through your SMSF, and it is important to seek proper advice in advance. Our team at McKays are experienced in SMSF law and can advise you regarding residential purchases as well as more complex commercial arrangements.