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Case study - Buy property with borrowings

Scenario:

Emma and Tom Freeman wish to use their Super to purchase a residential Property. After learning more about the SMSF, they decide to set up an SMSF to do so. Within their SMSF, they have $250,000 in cash and $50,000 in other assets. They are interested in acquiring a residential Property worth $500,000. This means that they don't have sufficient funds in their SMSF to afford the full price of the Property. In this situation, Emma and Tom choose to apply for an SMSF Property Loan.

Buy property with borrowings

How does it work?

After seeking independent Financial and Legal advice to ensure that their Investment decision complies with the relevant superannuation laws, they are assured that they are eligible for buying this residential Property with borrowings.

As the SMSF is not allowed to purchase the Property directly where borrowings are used, they will need to set up a separate holding trust, typically referred to as a Bare Trust or Security Custodian Trust, which will be the legal owner of the Property.

To purchase the property, the Freeman SMSF can use the $250,000 it has available in cash and borrow the remaining funds plus other associated costs, using the residential Property as security for the loan.

Whilst the Security Custodian Trustee will actually purchase the Property it is the SMSF who will borrow from the Lender to fund the Property purchase and receive the rental income. The rent can be used by the SMSF trustees, Emma and Tom, to make the loan repayments. Once the loan is repaid the legal ownership of the property can be transferred to the Freeman SMSF.

Importantly, the loan is a limited recourse loan. That means in the event that the SMSF defaults on the Loan the Lender can repossess or sell the Property only, but cannot repossess or sell any other asset under the Freeman SMSF to recoup any loan shortfall (if any).

It is complicated.

SMSF Loan Arrangements are complicated! Failure to correctly implement the above arrangements may result in a breach of Superannuation Laws. The breach may mean the SMSF is not complying, which may result in significant tax penalties or may result in civil or criminal consequences for the SMSF Trustees. So it is important to get it right. To assist with this complicated process, ESUPERFUND will guide the Trustees through the entire setup process to ensure the Property purchase is executed correctly. For more information on the loan theory with borrowings, please visit here.

Before you start

An SMSF can be a great vehicle to take back control of your Super but an SMSF may not be right for everyone. We have conveniently summarised other factors to consider when contemplating setting up an SMSF here. We also assist you in understanding what is involved in the ongoing management of your SMSF via our Free SMSF Learning Centre here.

If you want to learn more about SMSFs, download an information pack today.

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