SMSF property borrowing presents costly pitfalls

Borrowing to purchase property through a self-managed super fund (SMSF) can be a complex process of costly pitfalls if trustees fail to follow the rules, according to Perpetual Private Wealth’s head of strategic advice Chris Balalovski.

Balalovski said borrowing within an SMSF could provide long-term benefits as long as members and trustees complied with the rules.

“It’s an opportunity to grow your wealth even faster, within a concessionally taxed environment,” he said. “It can provide greater diversification by broadening the range of assets within the fund and it allows individuals to acquire the types of assets they’re most comfortable with.”

However, while trustees could borrow to purchase and repair a property, they could not borrow to improve it. Balalovski explained that repairing or maintaining an asset entailed restoring it to its original functionality, or ensuring it retained functionality. Trustees need to be careful not to improve the property in any way.

“For example, fixing a burst electric hot water system would be seen as a repair. However, replacing a burst electric hot water system with a solar one, thereby enhancing the value of the property, may be considered as an ‘improvement’,” he said.

Undertaking expenditure on improvements with the superannuation fund’s own money could also be problematic as the Commissioner of Taxation considered that some improvements to assets would result in the creation of an entirely new asset, which was prohibited.

An alternative was for the superannuation fund to borrow and use those funds to invest in a related trust, which itself acquired the relevant real estate.

“As the trust isn’t prohibited from repairing, maintaining, improving, developing or replacing the asset in any way, the result is that the fund has effectively acquired the underlying real estate, but it can now be dealt with in a much more flexible and appropriate way,” Balalovski said.