Self-Managed Super Annuation Funds (SMSFs) are increasingly becoming more popular among Australians who want to have more control over their retirement savings. According to the Australian Tax Office (ATO) in March 2024, there were 616,400 SMSFs which was an increase from 609,301 the previous year.
We’re also seeing an increased popularity in property investing using SMSF, with a lot of it attributing to the numerous tax benefits that SMSF property investing offers. In this article, we’ll uncover just what those benefits are, and some key considerations to be aware of to set yourself up for success.
So what are the tax Benefits of Investing in Property Using an SMSF?
You can stand to enjoy the following tax benefits when you invest in property through your SMSF:
- Concessional tax rate on rental income
- Tax deductions on property-related expenses
- Reduced capital gains tax
- You can claim tax depreciation on your SMSF property
- Tax deductions on your SMSF property loan interest
- Tax-free income on retirement
Let’s break each of them down:
1. Concessional Tax Rate on Rental Income
When you buy and hold an investment property under your own name, the tax payable on your rental income will be based on your personal tax rate, which sometimes can go as high as 45%. And if you decide to hold the same property under a company, the tax rate will be 30%.
On the other hand, SMSFs are the tax rate on rental income is set at 15%, regardless of how much you earn outside of your super.
Example of leverage concessional tax rate
Let’s say Peter own’s an SMSF investment property and receives $500 per week in rental income. Peter also has a total of $2,500 in deductions for allowable expenses across the year. This means Peter has made a profit of $23,500. Because it’s an SMSF investment property Peter only needs to pay 15% tax, bringing his total tax liability to $3,525.
Peter works as a GM at a Cyber Security Company earning $250,000 per year, if he had the same property as a private investment, then the rental income of $23,500 would be taxed at 45%, bringing his total tax liability to $10,575.
Therefore Peter would’ve paid an extra $7,050 in taxes had it been a private investment.
2. Property related expenses are tax deductible
Another great benefit for SMSF investors is that property related expenses are tax deductible, which can help considerably in reducing your total tax liability.
These expenses include:
- Property management fees – Expenses classified under property management fees include council fees, body corporate fees, insurance, advertising costs to find tenants, and the cost of hiring a property management service to manage the property for you.
- Professional adviser fees – If you hire a tax agent, mortgage broker, or financial planner to help you make wise investment property decisions, you can deduct the cost of hiring them from your taxes.
- Legal expenses – You may incur legal expenses, such as having a lawyer draft tenancy agreements or contractor agreements.
- Property repairs and maintenance – Expenses associated with property repairs and maintenance include cleaning, gardening, painting, pest control, and lawn mowing
- Property improvement and renovations – These are costs associated with activities that improve the property’s value, such as installing a new bathtub or kitchen gas stove.
The last two types of expenses can cause a bit of confusion. Keep in mind that there are different tax implications for deducting expenses associated with property maintenance and repairs, and renovation expenses that improve the property’s value.
While repair and maintenance expenses can be deducted in the year they’re incurred, property renovation and improvement expenses are treated as capital expenditures. They can only be deducted at 2.5% annually for 40 years or at 4% annually for 25 years.
3. Reduced Capital Gains tax
Capital gains tax gets reduced to the flast 15% on any gains that you make. Pensioners may get to enjoy being exempt from any capital gains tax if they decided to sell their SMSF property once they reach their pensioner stage.
Suppose you decide to sell it when you’re still in the accumulation phase and you’ve owned the property for more than 12 months, you still get a one-third discount on any capital gains you make from the sale. This lowers the capital gains tax liability to 10%.
Example of leveraging CGT benefits
From our rental income example, let’s say Peter bought his property for $500,000 and managed to sell it for $800,000 after 12 months. He’s made a capital gain of $300,000. With a capital gains tax of 10%, his total tax liability is only $30,000.
But if this was a private investment, then Peter would need to pay CGT on 50% of the gains. And because Peter makes over $180,000, he gets taxed at 45%. Which brings his total tax liability to $67,500. Meaning he’d have to pay an extra $37,500 in tax.
4. Claiming Tax Depreciation available for SMSF property
As a property gets older, it’s subject to wear and tear. This means that the property’s value depreciates every year.
Fortunately, the Australian Tax Office (ATO) allows property investors who’ve bought property through SMSF and generate income from it to claim property depreciation as a tax deduction. Depreciation is treated as an expense associated with owning an investment property.
There are two types of property depreciation deductions to know about:
- Capital Works Deduction (Division 43) – Division 43 deductions are associated with the general depreciation of the building’s structure. If constructed after September 1987, the structure of a residential building has an effective life of 40 years.
- Plant and Equipment (Division 40) – “Plant and equipment” is used to refer to the fixtures and fittings within the property. They’re known as easily removable assets, which include air conditioning units.
As with other property owners, SMSF property owners are eligible to make tax depreciation deduction claims for capital works and plant and equipment.
To make the most out of your SMSF property tax depreciation deductions, consider working with a quantity surveyor to draw up a tax depreciation schedule. This schedule outlines the value of both your Division 43 and Division 40 assets and their depreciation rates.
5. Interest on your SMSF Investment property loan is tax deductible
If you got a loan to purchase the investment property through SMSF, the loan’s interest is tax deductible. However, there’s one condition for that— you can only claim your loan interest if you used the full loan amount for the purchase of the investment property.
For example, if you only used a portion of the loan amount to place a deposit on the property and invested the rest in other fund investments, you’ll be in breach of the borrowing standards. Any amount not used for property purchase must be fully repaid to the lender.
6. Tax-free income at retirement
Once the SMSF enters the pension phase (after you retire at the age of 60), both the rental income and the capital gains become tax-free, significantly boosting the returns and saving more on taxes.
If you decide to sell the property after reaching the pension phase, you’re excluded from any capital gains tax altogether.
Note that there’s a $1.6 million transfer balance limit which is applied to the amount that can be used to start superannuation pensions that are in the retirement phase.
For example, if you bought a property worth $450,000 through your SMSF, held the property until you retired, and sold it for $580,000, you will not pay any capital gains tax. The $130,000 will be added to your retirement savings without paying any tax.
Tax considerations for your SMSF investment property
Here are some tax considerations to take into account before you think about investing in a property through your SMSF:
Being organised with record keeping
Record-keeping is an important aspect of managing your SMSF. You must have all your receipts and invoices to help you substantiate your tax deduction claims.
For example, we’ve seen that you could enjoy reduced capital gains if you decide to sell the property if you’re still in the accumulation phase and you’ve owned the property for more than 12 months. This means you must have records showing when you bought the property and how long you’ve owned it.
Similarly, if you wish to deduct property-related expenses from your tax, you must show how much you’ve been paying.
Poor record-keeping slows down the process of completing your fund’s account. On top of that, it may make it more difficult to audit your fund and also increase the likelihood of attracting penalties for breaching rules.
Ensuring you comply with rules set out by the ATO
Overseeing an SMSF isn’t an easy task. One consideration you must be aware of is compliance with rules and regulations set by the ATO.
There are various guidelines that you must follow, including borrowing arrangements, property use, and related-party transactions. Failure to adhere to them could lead to severe consequences.
If your SMSF is found to have breached any regulatory responsibilities, it can attract fines and civil or criminal proceedings. You also run the risk of paying the top marginal tax rate on all your property gains instead of enjoying it’s concessional 15%.
Not all property expenses are tax deductible
You must understand which property expenses you can deduct on your taxes, and which ones you can’t. Not all property expenses are tax deductible.
Here’s a breakdown of property expenses that may not be eligible for deduction:
- Expenses associated with the property’s purchase – You can’t claim the property’s purchase price, stamp duty, conveyancing fees, or building inspection fees.
- Cost of travelling to the investment property – You’re not eligible to claim travelling expenses related to visiting a residential property for inspections, maintenance, or rent collection. However, it might be possible to claim these expenses if you own a commercial property through your SMSF.
- Expenses paid for by the tenants – You can’t claim expenses such as water, gas, electricity, and any others that are paid for by the tenants.
- Costs of selling the property – You can’t claim costs associated with selling the property, such as legal fees and real estate agent commissions. However, you can include these costs in the selling price and reduce your capital gains tax obligation.
Interested in SMSF property investing?
While these tax benefits look enticing enough, they shouldn’t be the primary reason you invest in an investment property through SMSF. There are many other factors to consider, such as SMSF compliance laws and your cash flow and liquidity.
This is why you should consult with experts to see if SMSF property investing is right for you. Our team at Wayfinder understands all the ropes when it comes to purchasing SMSF investment properties. We’ll help you find a strategic investment property geared towards maximum returns in the future.
Contact us today for personalised service and expert guidance on strategic SMSF property investment plans that will maximise tax benefits
