Beverly and Chris run a successful creative agency in Sydney and had been told they could potentially buy property and lease it back to their own business. They were excited, because for them, the benefits were:
- they could use what they considered to be “idle” super monies to fund an asset they may not be able to afford outside super,
- they could continue getting a business deduction for rent (in their case 30% but this could be up to 46.5% if the business was held in a trust), with the super fund then only paying 15% income tax
- If they ever sold the premises, it would only attract 10% Capital Gains Tax, or even Nil tax if they held onto it until retirement
Chris and Beverly already had a Self Managed Super Fund (SMSF) with a little over $550,000 accumulated. The property they wanted to buy was valued at $600,000 but neither were keen on tying all of their super up in the property, and they already had other investments. Retaining a good level of liquidity was important, as was continued diversification.
They didn’t have access to additional funding to contribute to the super fund however, so (even though it was somewhat costly to establish and attracts a higher interest rate than a normal loan), a Limited Recourse Borrowing Arrangement (LRBA) loan from their bank was the most viable option.
Most major banks have LRBA loans, but they vary greatly in their ease of implementation and repayment features (eg some but not many have offset facilities). It’s also worth noting that banks will typically consider commercial property a riskier investment, and will impose a lower Loan to Value Ratio LVR), for example 60%.
To obtain the loan, cash is required, so Chris and Beverly needed to sell approximately $200,000 in shares and access other cash they already had. In all, they effectively funded $250,000 of the purchase price themselves, plus stamp duty and establishment costs (which amounted to around $35,000).The remaining $350,000 was borrowed using an offset facility meaning that all excess cash in the fund is reducing the interest costs. In Chris and Beverly’s case, they have only been able to contribute $50,000 per year using tax deductible concessional contributions (this means that the contributions are made before income tax is paid, such as Superannuation Guarantee Contributions (SGC) or salary sacrifice). These contributions are taxed at 15% in the super fund. Because both are in their 50’s, they will now be able to contribute up to $70,000 from 1 July 2014 to help reduce the debt. The rent being paid by the business at market rates, as well as dividends from their other investments are also reducing the interest payments.
Accurate legal agreements, including the arms-length lease agreement back to the company, and timing between all of the entities involved are the most critical to implement correctly with an LRBA loan. As it is a relatively new, and somewhat specialist transaction, you’ll often find the people you need to co-ordinate are not as familiar with the intricacies as they need to be, so you’ll need experienced specialists involved to avoid expensive mistakes.
And watch out – using the SMSF may not always be the most tax or cost effective strategy, depending on other options. So talk to your trusted advisers if you’re thinking about a strategy like this, or call Greenlight for further information and advice.