A client in their 60s purchased a commercial property more than a decade ago for $1 million. Recently, he sold it for $7 million, all within their Self-Managed Superannuation Fund (SMSF). Instead of facing a hefty Capital Gains Tax (CGT) rate of 47%, they paid only up to 10% in SMSF, saving over $1 million in taxes.
why do some people achieve such massive tax savings and profits through SMSF property investments while others face losses? What are the secrets to success or failure in property investing within an SMSF?
The Tax Advantage
One of the most significant advantages of SMSF property investment is the potential for substantial tax savings. The client’s story is a prime example of this. Investing in property within an SMSF offers a tax-efficient way to grow wealth.
Factors Leading to Success or Failure
- Understanding Costs: Property investment within an SMSF involves higher entry costs compared to traditional investment avenues, such as managed funds in superannuation. Management expenses, including accountant, auditor, and financial adviser fees if investors have one, can add up. Additionally, interest rates on SMSF property loans are typically higher.
- Tax Implications: After the age of 60, SMSF pensions enjoy tax-free concessions up to a balance of 1.9 million dollars for each member, and capital gains tax (CGT) rates within superannuation are typically lower than the average marginal tax rates of individual investors. It’s important to note that in an SMSF, tax is only paid when profits are realised. If there’s no profit, there’s no tax payable. However, a key distinction from personal investments is that SMSF losses incurred from property cannot be offset against taxable income outside of the fund.
- Regulatory Compliance: SMSF trustees must adhere to strict regulations, which can limit the flexibility of property investment decisions and rental arrangements.
- Investor Expertise: The key differentiator in SMSF property investment often hinges on an investor’s level of sophistication in the property market. For those who opt for default options like balanced portfolios within their superannuation funds, the average returns have hovered between 7% and 8% over the past decade.
However, it’s important to recognise that property investment entails more than just the fees mentioned earlier. There are additional ongoing costs to consider, including rates, insurance, body corporate fees, land tax, property management fees (if an agent is used), and expenses related to repairs and maintenance. To surpass the returns achieved by default balanced funds, one needs to calculate precisely how much return is required to offset these costs and still yield a superior outcome.
In Australia, individuals typically purchase one or two properties throughout their lifetime on average. Achieving returns that outperform those managed by professional fund managers after all the costs can be challenging, especially when investors consider the power of compounding over time. The client mentioned earlier is a prime example of a sophisticated investor with years of property market experience. Their success in the SMSF property investment can be attributed to this expertise.
Diversification and Risk
Concentrating one’s retirement assets into one or two properties within an SMSF can indeed be a high-risk strategy, particularly for individuals lacking experience in the property market. Diversification plays a crucial role in risk mitigation, and depending excessively on property investments may result in unfavourable outcomes for retirement. It’s important to remember that superannuation primarily serves as a vehicle for securing one’s retirement future, emphasising the need for a well-balanced and diversified investment approach within an SMSF.
In conclusion, investing in property within an SMSF is a complex strategy, especially when it involves borrowings. Potential investors should perform a self-assessment to evaluate the strategy’s costs, their own expertise, and their ability to make informed decisions in a dynamic property market. While SMSFs can offer significant benefits, they should be approached with caution and a clear understanding of the associated risks and opportunities if individuals intend to establish an SMSF for property market investments.
