How business owners can BUY their premises using their super – Part 1
In business one of the highest overheads you have is rent. Would you rather all that rent money going into your landlord’s pockets or funding your retirement nest egg?
Due to recent changes to the superannuation laws, you are now able to combine your existing superannuation savings with a special type of loan making it possible to own your business premises without the previously required large amount of capital.
How does the strategy work?
The strategy involves the following steps:
1. Transfer your (and your spouse’s / partners) existing superannuation to a self-managed super fund (SMSF)
2. A contract is signed in the name of a custodian trustee (a company which you own and control) for the purchase of the property and obtains the custodian trust documents
3. The SMSF pays the required deposit using the monies in the SMSF (from your industry or retail super fund combined with any contributions)
4. The SMSF obtains a special limited recourse loan from either a bank, or from a related party (or a combination of both)
5. The property purchased is settled as normal with the SMSF paying all associated fees and costs
The main difference between this type of property purchase and a normal property purchase is that the title of the property is held by the custodian trust on behalf of the SMSF – rather than directly in the name of the SMSF.
All rental income, expenses and loan repayments are received into and paid by the SMSF directly however, so the custodian trust should simply be thought of as a legal tool which enables the SMSF to obtain a loan (which it can’t do otherwise).
The limited recourse loan differs from a normal loan because in the case of a default, the lenders rights are limited to the underlying property – they cannot touch any other assets of the SMSF or the individuals as they can with a typical investment property or home loan.
How much super do I need?
A good rule of thumb is that you will need to have approximately 35% of the purchase value of the property plus enough to cover all purchase costs including but not limited to:
- Stamp duty
- Legal fees
- Loan establishment fees
- Bank legal fees
- SMSF and custodian trust establishment fees
One of the great things about a SMSF is that you can have up to four members who can combine their existing superannuation savings and contributions which can be used to fund the deposit and purchase costs.
The other members may include your spouse, other family members, your business partners however you cannot include any of your employees.
If you determine that you don’t quite have enough in your current superannuation accounts to cover the deposit and purchase costs, you can make additional tax deductible contributions from your business to your SMSF to give it a boost. Currently, the current maximum annual contribution cap amounts are $35 000 per annum for those over 60 years old, and upto $35,000 for anyone younger. As of 1 July 2014 those over 50, will be able to contribute up to $35,000 per annum and everyone else $25,000.
How much can I borrow?
The current maximum LVR (loan-to-value ratio) available for commercial properties using a limited recourse loan is 70%. Most of the major banks have a limited recourse loan product suitable for SMSFs.
However, just because you can borrow this amount, it doesn’t mean you should. Before signing any contracts you need to be aware of the cash flow implications. The strategy only works effectively when the rent your business is paying to your SMSF is more than all the expenses and outgoings (including interest and principal repayments) that are going out – i.e. you need the property to be cash flow positive.
If your SMSF property is not cash flow positive, then you will actually end up in a worse position than you were originally when you were paying rent to a third party landlord. You or your business will be constantly tipping in additional monies to cover all the outgoings in addition to the rent.
It is important to realise that the limited recourse loan application process for business owners is generally more onerous (and about three weeks more time consuming) than it is for wage and salary earners. This is because the banks need to look at the underlying profitability and financial health of your business as it will be responsible for paying the rent.
For this reason it is essential that your business be in a strong profit and cash flow position with a good credit history. Your will also need to have at least two years of up to date financial accounts and income tax returns lodged and available, cash flow projections and no debts with the ATO or other government agencies.
If you can’t tick all these boxes you need to see your accountant and develop an action plan to get your business in a position where you will be able to obtain a limited recourse loan to enable your SMSF to purchase the property.
Do I have to borrow from a bank?
No. It is possible if you have available equity on other properties you own to draw down another loan or line of credit and on-lend these funds to your SMSF as a ‘member financed’ limited recourse loan.
The major advantage of this strategy is that you will save significant upfront and ongoing costs that can be applicable if your SMSF borrows from the bank directly.
A disadvantage however is that this equity will not be available for other investment purchases while the property owned by the SMSF (via the custodian trust) will sit there unencumbered with loan or mortgage registered against its title.
Another benefit is that any surplus cash built up in your SMSF by rent and contributions paid by your business can be used to repay the principal on the loan. This is a very tax effective way of legitimately extracting cash from your company without having to worry about Division 7A loans, deemed dividends or paying a high personal marginal tax rate.
There is also the ability to combine a bank limited recourse loan with a loan from you personally or a related entity (like a family trust). This strategy is especially attractive to younger business owners as it enables them to inject some capital into the SMSF for the purchase of the property, and then legitimately extract the money out of the SMSF as interest and principal loan repayments.
This strategy gives the best of both worlds – purchase of a capital appreciating asset in the most tax effective structure available but not having all of the deposit monies trapped until retirement.
If you operate a business via a company, you may be tempted to make a loan to your SMSF to help fund the purchase of a property in your SMSF. Although this strategy is possible, it is not ideal because if your company ever gets into financial difficulties, an administrator or liquidator could recall the loan and force your SMSF to sell the property to repay the amount. This negates some of the superb asset protection the SMSF provides.
Limited recourse loans are able to be refinanced the same as normal loans, however there is a limited choice of SMSF loan providers at the moment, so if possible try to find a loan that is going to be suitable for as long as possible.
Part 2 will cover the following:
- How much it costs (including upfront and ongoing costs with an example)
- What types of properties are suitable
- Restrictions and limitations to be aware of
- Tax free income
- Summary of benefits
- How to get started
- How I can help
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