Pros and cons of gearing in SMSFs
Since gearing in superannuation was allowed, it has proved to be increasingly popular among trustees. This is because it enables SMSFs to invest in direct property, something that can be difficult to achieve without borrowing. But it may not be the ideal strategy for every SMSF and it’s important to understand the pros and cons.
If the SMSF positively gears the investment, that is, the income received exceeds loan repayments and other expenses, the additional income is taxed at the SMSF’s marginal tax rate, which is generally lower when compared with non-superannuation income.
Depending on the tax situation of the SMSF and the investment strategy in place, this may not be to the fund’s advantage. In some instances, negative gearing may provide a better tax outcome for the fund.
To ensure that the gearing plan meets the SMSF’s strategic, long-term requirements, it’s important to calculate the loan-to-valuation ratio and seek professional advice before making any decisions.
The type of property purchased must also be carefully considered because the ATO states that a loan may only be used to purchase a single property, described as a “single acquirable asset”.
In its May 2012 ruling (SMSFR 2012/1EC), the ATO has attempted to simplify its definition of a “single acquirable asset”. In basic terms, it explains that properties on separate titles must have a separate loan for each title.
In certain situations, however, properties on separate titles may be treated as single acquirable assets. For example, a block of land with a factory, purchased on separate titles, may be deemed a single asset because neither could operate profitably without the other.
If an inappropriate property is purchased, or an incorrect strategy put into place, it may take the fund quite some time to recover – from both tax and investment points of view – because the costs and time associated with liquidating the asset could be significant.
On the other hand, one of the most advantageous geared investments is purchasing a commercial office from which the SMSF members conduct their professional business.
Purchase the right office and the benefits are substantial:
- The tenants tend to be reliable.
- The tenants can claim a tax deduction on the rent paid.
- The rental income received is considered a concessional contribution to the fund.
- The rent reduces the borrowed amount.
- The sale of the property after members reach age 55 may have capital gains tax benefits.
It’s important that trustees be mindful that if an office with a car park is purchased, but the premises and car space are on separate titles, they will not qualify as a single acquirable asset.
With any investment, timing is crucial – interest rates on borrowed funds fluctuate, as do asset values. Trustees must carefully assess the trust’s future investment plans before making a decision. This will ensure that they make the right investment choices at the right time.
An asset bought or sold at the wrong time can have a long-term impact on the SMSF’s investment plans.
Please contact us on 02 9318 6400 or fred.tortora@surrypartners.com.au if you have any questions. Mistakes with acquiring assets may be costly, but professional advice is priceless.
Sources:
www.afrsmartinvestor.com “The pros and cons of borrowing” John Wasiliev 7 March 2012
www.propertyobserver.com.au “Clarity for SMSF property investors as ATO defines ‘single acquirable asset’” Larry Schlesinger 24 May 2012
www.smh.com.au “Super strategy may not stack up” John Kavanagh 23 June 2012