Many business owners and medical professionals are missing out on this commercial property strategy to invest in high quality assets, that grows their superannuation balance in a reduced tax setting while giving their business legitimate deductions.
In today's feature article, we look at the tax efficient strategy of growing your superannuation nest egg by owning commercial property in your Self-Managed Super Fund (SMSF) and renting the property out to your business or professional practice.
In this article, we will explain everything you need to know about investing in commercial property within your SMSF, including how the strategy works, who it is best suited for and any challenges you need to be mindful of - all explained in simple and understandable language.
So let's dive in!
At a glance
Having your SMSF invest in a suitable commercial property and renting it to your business or practice is a highly leveraged and tax efficient method of simultaneously growing your superannuation nest egg while providing deductions to your business
The strategy works by acquiring an appropriate commercial property within the business owner's or professional practitioner's SMSF and then renting the property to the owner's business or practice.
The leverage and efficiency is derived by income coming into the SMSF, which is taxed at 15%, while the business is entitled to a deduction between 25%-47%, depending on the marginal tax rate
The strategy can be utilised by anyone, though it is particularly beneficial for individuals who are:
owners of a business or
principal practitioners of a professional practice (e.g. doctors in a medical practice)
The main "watch-outs" of the strategy are:
Additional cost and burden of establishing and running a SMSF (assuming you don't have one already)
Financing is more challenging as there are restrictions on the types of loan permissible in a SMSF
Restrictions on access to superannuation income
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Article
Overview - investing in commercial property and renting it to your business
The strategy of renting out commercial property from within a SMSF has been around for years. However, clients often don't understand how it works, the benefits and the "watch-outs" you need to be mindful before determining before entering into the strategy.
As a result, individuals for whom this strategy works best miss a golden opportunity to build their superannuation nest-egg all while taking advantage of expenses they would ordinarily otherwise have, thereby reducing their business earnings and reducing their overall tax rate.
How does the strategy work?
In a nutshell, the strategy relies on earning income in a low-taxed vehicle (in this case, the SMSF), while obtaining legitimate deductions in a higher taxed setting, such as a business.
This has the effect of reducing your tax bill in a highly taxed vehicle (i.e. your business or professional practice), while earning income in a lower taxed environment, namely, your SMSF.
The diagram below demonstrates how this structure works.
As can be seen in the above diagram, our business owner or professional practitioner, Jenny, has set up an SMSF and acquired an appropriate commercial property and rented the property to her business.
The overall result for Jenny is that she is using expenses she would have otherwise paid, to increase her wealth in her super, which is minimally taxed.
The advantages of the strategy
There are several advantages to purchasing commercial property through your SMSF and utilising it in your business:
Tax effectiveness: The 15% superannuation income tax rate makes SMSF property investment a tax-effective option. Meanwhile, your business is deriving a deduction against income that is taxed at 25%-47%. This increases your overall wealth when viewing the business and the SMSF combined.
Quicker asset growth: By paying rent to yourself instead of a landlord, you can grow your SMSF more quickly.
Consistent payments into your super: Business owners can sometimes be notoriously bad at paying into their own superannuation. This strategy sets up a method which facilitates periodic payments into your superannuation and grows the superannuation balance.
Increased asset protection: As your business is a separate entity from your SMSF, SMSF property investment can provide increased asset protection. Further, any loan against a property needs to be a limited recourse loan, which limits the assets a creditor could use as collateral (see below for more information).
Secure tenancy: As the property is held by your SMSF, you have a secure tenancy in the property and additional flexibility to do with the property what you need to for the business.
Who does this strategy work best for?
There are two specific groups of people who benefit most from this strategy:
business owners and
professional practitioners (i.e. medical professionals) who run their own clinic.
Business owners
Generally speaking, businesses very often need premises to operate in. The business owner can either rent from an external landlord, purchase the premises themselves or have the business acquire it.
When you have your SMSF acquire the property and rent it to the business, you are benefitting at both ends of the arrangement. You get the deduction for rent payments you would otherwise be paying to a third party, while deriving income in your SMSF which is building a superannuation nest egg.
As a result, even without the business owner making their own contribution into a superannuation fund, the super balance is growing due to the income being derived via rent.
The also has the added benefit of ensuring the business owner is growing their super, with consistent payments from the business (some business owners can be terrible at making contributions into their own super!).
Medical professionals
Buying medical premises is a very popular strategy for medical professionals, notably doctors and dentists, and other professional practitioners including occupational therapists, psychologists, physiotherapists etc.
For example, in a medical practice where there are a number of medical professionals working together, each medical professional will likely have a considerable amount in their super from years of working following their residencies.
Utilising the same strategy as the business owners above, the medical professionals can invest in premises via their respective SMSFs.
This strategy is achieved by establishing a unit trust to purchase the medical premises and establish a medical practice management business. Each of the practitioners' SMSFs can then acquire a stake in the unit trust, which pays out distributions to each of the funds, after accounting for expenses.
They each then receive a tax deduction on their medical business, and the practice management income (which includes rent) in their SMSF falls under the low tax rate of 15%.
What steps do I take to have the strategy established?
To get started in the SMSF property market, there are several steps you need to follow:
Ensure you have enough funds for a commercial property purchase. If you’re borrowing to buy a commercial property, you should expect to have a deposit of between 30%—40%, plus stamp duty. Please note, these types of loans need to be under a limited recourse borrowing arrangement (LRBA). An LBRA effectively limits a bank or creditor from selling anything other than the securitised asset in the event of default. To establish this type of loan, you will need to also set up of a bare trust within your SMSF, which effectively ends once the loan is fully repaid. While this may sound complex, your accountant and/or lawyer can assist with this step and it is relatively straightforward.
Identify the property you want to purchase, and ensure you can afford it, either via lending or a cash payment. To this end, unless you are highly proficient in understanding and sourcing commercial property, engaging an experienced buying agent that specialises in the type of commercial property is certainly well-worth considering.
Set up a commercial lease arrangement between your business and the SMSF that owns the property, and document it with a lease agreement.
Pay the periodic rent or administration fee from your business to the SMSF.
Ensure the SMSF continues to comply with all SMSF obligations, including annual audits and reporting
What are the main factors to be aware of prior to entering this agreement?
While this strategy sounds great, there are some considerations you need to be mindful of:
SMSF earnings cannot be accessed until retirement
While it is great that the SMSF is deriving income, just like any other superannuation fund, the income being derived by the property cannot be accessed until retirement.
Therefore, this should not be considered a wealth investing strategy for the short-term, but rather a tax efficient method to build your superannuation balance using expenses you would otherwise incur within your business or practice.
Financing may be challenging and a larger deposit is often required
Because of the strict nature of limited recourse borrowing arrangements (LRBA) and limitation on creditors to access additional assets in the event of default, banks typically require more equity in the SMSF (sometimes as much as 30-40% deposit) and banks may also ask for personal guarantees.
Again, engaging a finance broker who understands this type of lending can be very worthwhile.
SMSF establishment and maintenance costs
Setting up the structure, including the various trusts and the SMSF itself, as well as establishing the various rental and administrative services agreements requires effort and some cost.
In addition, like any SMSF, there are annual regulatory requirements, such as audits, that need to occur.
The Closing Word
This strategy can be highly effective for the right individual looking to grow their superannuation in a highly tax efficient manner and ensure that the business and/or practice is building towards the person's overall wealth as much as possible by sending income, otherwise going to third parties, into their superannuation.
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Sapphire Bay Partners is always delighted to help!
We love working with dynamic, proactive clients and helping their businesses grow.
If you would like assistance, feel free to reach out to us.
Tel: + 61 3 9563 4666
Email: letstalk@sapphirebay.com.au
Important Information
This is general information only so it doesn’t take into account your objectives, financial situation or needs. Sapphire Bay Partners is not giving you advice or recommendations (including tax advice), and there may be other ways to manage finances, planning and decisions for your business.
Carefully consider what’s right for you, and ask your lawyer, accountant or financial planner if you need help. Alternatively, feel free to reach out to Sapphire Bay Partners for assistance or referrals to an appropriate professional. We’re always happy to help!
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