Is purchasing property through a shared SMSF a good idea?
I recently encountered a case where two business partners were looking to buy business premises together. They had been told that the best way to do this was to enter a self-managed superannuation fund (SMSF) with both of them as members and then borrow to purchase and hold the property through the SMSF.
While this is indeed one option, and will generally still achieve the end goal of acquiring the property, it is probably not the most beneficial approach.
A client joined our firm recently who had previously implemented this type of strategy. Their previous advisor had given no consideration to the possible future exit of one of the investors, future investment needs of each member or the death of a member. Any of these scenarios would likely cause some major issues for the SMSF, its assets and members. We don’t recommend this option in these circumstances.
This approach also installs the business partners as related parties under the SIS Act, which effectively removes one perceived benefit of this kind of approach – the ability to utilise an uncontrolled fixed unit trust with gearing via an SMSF.
A smarter, more flexible approach
Rather than entering a joint SMSF, the partners should consider setting up a fixed unit trust.
With this approach, each of them will still hold separate SMSFs which can be utilised to purchase 50% of the units in the trust. This trust, being an uncontrolled and unrelated trust of each person, could then borrow to buy the difference needed to complete the desired property purchase.
Pros and cons of the two approaches
Scenario 1 - One SMSF with LRBA and two investors as members
1. When the directors are different ages (say 36 and 55) they will have different investment mix requirements. The older member may want to have access to an income stream that may not be available because the SMSF is geared towards paying down debt and building a portfolio.
2. If one member dies and their entitlement is to be paid as a death benefit, the remaining investor has to either contribute more funds to the SMSF, or sell the property to allow the death benefit to be paid. Cross insurance arrangements are not permitted in an SMSF to deal with this risk.
3. If the building purchased has development potential, this work cannot be carried out while the LRBA is in place. The SMSF may not have sufficient future wealth to carry out significant development or improvements once LRBA is paid down.
4. If one of the two investors dies and the member nominations are ineffective, the remaining investor can make decisions on the death benefit payment as a surviving trustee. These might not align with the deceased estate.
1. Cheaper and easier to arrange than having a fixed unit trust in place and running two separate SMSFs.
Scenario 2 - Two separate SMSFs using a fixed unit trust 50/50 investment by each SMSF
1. Higher structuring costs, and the ongoing cost of running two SMSFs
2. By law, one SMSF cannot buy out the other SMSF’s units while there is debt over the property in the unit trust.
1. The two SMSFs are not dealing with LRBA rules. Due to the debt in the trust, the members of the SMSFs would possibly need to act as guarantors for the bank loan. As long as they are not acting as trustee of the SMSF, with no recovery over other SMSF assets, it is not an issue.
2. In the event of the death of a member in one SMSF, the SMSF could pay the units in the trust as an “in-specie death benefit” to the dependant or legal personal representative to put in the estate. By doing this, the property is further protected, and there is no need for it to be sold to pay death benefits.
3. The investors can implement their own investment strategies and mixes within their independent SMSFs.
4. If one investor does pass away, the surviving investor has no control over the deceased investors’ SMSF or how death benefits are paid.
5. The property can be improved and altered in the trust as LRBA rules would not apply. Further lending to fund improvements and investment can be carried out in the trust without having to deal with contribution caps that would be an issue in a shared SMSF.
Hopefully this has given some insight into an alternative approach to solving this issue. When all factors are considered, quick and easy options do not always produce the best outcomes for our clients.
Please don’t hesitate to get in touch if you need assistance with structuring and implementing your SMSF.