10 Common Mistakes When Buying Property With Your SMSF

Many trustees make mistakes, especially when they are just starting out. Here are some of the most common mistakes made by trustees and how you can avoid them. Throughout the Super Finance Professional Network we pride ourselves on this knowledge to make sure that you do not fall into the same traps.

1) Purchasing residential property from a related party.

You would be surprised at how often this happens. The most common example is people buying personal investment properties from themselves. You cannot do this. The consequences are quite severe as well, as in addition to the potential fines imposed by the ATO for non-compliance, you will also get stung with stamp duty, not once, but twice. Firstly when your SMSF buys the asset, and secondly when you have to fix the problem and move the property back to your personal name.

2) Paying off your personal investment property using SMSF funds.

The common excuse for this mistake is that the trustee will say their personal investment property is for their retirement and, as such, they took money from the SMSF bank account to cover a few monthly mortgage repayments because they were short on personal funds – and as their SMSF is for their retirement, then there should be no issues, right? Wrong. If you want to use SMSF funds to make mortgage repayments, the property must be beneficially owned by the SMSF.

Making this mistake usually always results in your SMSF Annual Reports being ‘Qualified’, meaning, the ATO are going to come to you for answers and may issue a penalty notice. If you do not fix the problem (i.e. beg for forgiveness and pay back the funds to the SMSF with interest) you’re at a risk of the ATO deeming your fund non-complying.

3) Using residential property for personal use.

As tempting as a holiday house down the coast sounds, do not be tempted to buy one in your SMSF if you plan on using it for personal use. Although this is a hard contravention for SMSF auditors to
pick up on (as personal use can be covered up and not reported) the ATO is conducting random inspections on these types of properties. If you do want to get some personal use out of your SMSF property, maybe consider a commercial premises or even a farm – there are some pretty interesting rules around rural property where you can live on the premises while running a business as well (note that lending is very difficult to obtain for this strategy though) as discussed in the above chapters.

4) Using non-compliant related party loans.

The ATO has recently clarified that it is no longer possible to make a related party loan to your SMSF to buy an asset and for the SMSF to pay zero interest to you. If you are making a personal loan to your SMSF the terms of the loan must also be on commercial terms (and also meet the single acquirable asset rules). The common test to prove if it is a commercial loan is to say if you walked into a bank, would they offer a loan on the same or similar terms? If not, you might want to consider checking with the SMSF auditor what you are planning on doing prior to going ahead and implementing the loan to see if they would have any issues with it.

5) Breaching the Single Acquirable Asset Rule – Repairing, Maintaining and Improving the Property.

When your SMSF takes out a loan to buy an asset, it must be used only to purchase one asset. This is why it not possible to buy house and land packages, as these types of deals are normally made up of 2 contracts (one for the land and one for the house) and 2 loans (one for the land and a construction loan). The issue is two fold:
a) You can take out a loan to buy the land (so long as you can find a bank that will lend to you to do this. Serviceability for the SMSF often turns banks off lending to buy vacant land blocks), but you cannot then build on the land while it is under mortgage – even with cash reserves in your SMSF. Doing so would change the asset (i.e. it would no longer be a vacant block of land, it would be a block of land with a house on it). This is a breach of the single acquirable asset rules. See chapter 6 above.

b) Secondly, your SMSF cannot get a loan to build a house, even if your SMSF bought the land with cash (i.e. no loan). The reason for this is that the ATO says that a construction contract is made up of 100’s of different items (bricks, windows, wood etc) and as such, you are not buying a ‘single acquirable asset’ with the borrowed monies. If you want to do a project such as this, you would have to have sufficient cash in your SMSF to carry out the project without needing assistance of a loan as discussed in chapter 6 above.

What about Off The Plan Apartments? Off The Plan apartments are different to house and land packages because you are buying a one contract, “turn-key”, asset. You pay a 10% deposit up front and then pay the balance at settlement for the completed project with the assistance of an SMSF loan.

6) Paying rent into personal bank accounts, and not into the SMSFs bank account.

A common question that I am asked is “when the tenant pays the rent, does it go to me personally, or does the SMSF get to keep it?” The answer is that the property belongs to the SMSF, so the SMSF gets to keep all income that is generated from it. On the same note, the SMSF is also liable to pay all expenses to do with the running of the property (think interest, rates, water etc). This comes back to the Sole Purpose Test – you are not allowed to get a personal benefit from the SMSF. See chapter 4 above

7) Buying properties in high risk zones, such as mining towns

I am not an expert at picking the best places to buy property and you will never hear me say
otherwise. I team up with other professionals to provide my clients with this advice. One thing that
I have seen all too often is people buying properties in high risk areas, only for the market to turn
and their properties to be well underwater.
From Townsville to Karratha, the last 4 years has been particularly brutal for property held outside
the major capital cities. People seem to be willing to take more risk with their superannuation
money compared to the risk they would normally take with their own funds. As a general rule of
thumb, if you don’t think you would make the investment in your own name, you should probably
think long and hard about making the investment decision for your SMSF.
8) Purchasing the property in the wrong entity
This is more common than you think. When you first set up an SMSF, there is a feeling of joy – the
whole investment universe is now open for you to consider. You are eager, keen and excited to get
your teeth stuck into investing in property. You know that your SMSF can do it; you have seen the
adverts and your mate at the fishing club has told you that he is doing it too. Here’s how it plays out:
• You turn up to an auction on the weekend to buy the apartment that you have been keeping an
eye on, and the price looks right.
• Your funds have been rolled over from your existing super fund to fund the deposit and are
sitting in the SMSF bank account. You think you are ready to go.
• The auctioneer calls last bids, you look around and you are the last person with their paddle in
the air. The hammer comes down; you are the highest bidder.
• You go to the back of the room and sign the contract of sale in the name of your SMSF.
• You go home, have a glass of wine to celebrate.
• The next day you call up your bank to let them know that you have purchased a property and need
to finalise the loan (see below issue on not organising finance prior to signing a contract of sale).
• Everything is going swimmingly until your bank’s solicitors come back and tell you that the
current arrangement is in breach of the superannuation legislation because the property has not
been purchased by a custodian trustee. See chapter 6 for more details.
• What do you do?!
• Well, you pretty much have 2 choices.
– Firstly, you can walk away from the deposit and the whole problem disappears, as with the
10% that you put down. Usually not the preferred option.
– Secondly, you can go back to the vendor and beg them to rescind the contract of sale and
sign a new one, with the correct entity on it. The reason why you have to rescind and reexecute
is that people in this situation often have not set up the second company required to
act as custodian trustee. As you cannot backdate the setup of a company (ASIC won’t allow
it), if you simply change the purchasing entity on the original contract it will be dated prior
to the establishment of the custodian trustee company – obviously this cannot be a valid
transaction (i.e. how can a company enter into a transaction prior to it being incorporated?).
I suggest giving your adviser and your conveyancer a call immediately if you

9) Not getting borrowing organised prior to contract signing.
There are 2 scenarios that I have seen where this situation can turn into costly errors.
Firstly, when an SMSF paid a 10% deposit and exchanged contracts without speaking to a Mortgage
Broker (or bank) prior. The trustee was under the impression that the SMSF could borrow up to 95%
of the sale price, as they had just purchased a property in their own personal capacity, where this
was allowed. They got a rude shock when trying to source a loan and it turned out that they could
not find a bank willing to lend past 80% for SMSF. So what did they do? Settlement was in 4 weeks.
Luckily for this trustee, they had enough capital in their own personal capacity to make a significant
non-concessional contribution into their SMSF to add to the purchase price of the property. If they
didn’t, they would have lost the deposit as they would not have been able to settle.
The key learning point here is to always speak to a qualified mortgage broker to get
an idea on your borrowing capacity prior to exchanging contracts.
The second scenario was a bit unlucky for the trustees that got caught up in it. In mid/late 2015
the major banks all tightened their SMSF lending requirements (to comply with new government
liquidity and capital requirements) and many of them dropped their LVRs to 70%. AMP (at the
time a major lender in this space) disappeared completely from the sector and withdrew all SMSF
lending, only to return to the market 8 months later.
The issue then was that many SMSF trustees had purchased Off The Plan apartments 12-18
months prior to this change and had been given pre-approval for loans based on 80% LVRs. When
settlement came around the banks told them they had to contribute an extra 10% to the purchase
price to bring the LVR down to 70%. As you can probably envisage, some trustees did not have the
extra 10% in their SMSF to meet this requirement (on a $450,000 property, this means having to
ASSET MANAGEMENT 29
get another $45,000 into your superfund) and had no choice but to borrow money against their
personal homes, businesses, or family members to make the contribution to their SMSFs to meet the
higher required deposit amount.
The point to take out of this is that is wise to go into these transactions with a buffer up your sleeve
(especially for Off The Plan developments), as you never know when the rules are going to change
and catch you off guard.
10) Not having sufficient liquidity in the SMSF to support a pension payment
Let’s assume the SMSF has only one asset, it is a property worth $1 million at the last 30 June
valuation. The property has a $500,000 loan against it and as such has only slightly positive cash
flow by $10,000 each year (i.e. where rent received is only slightly greater than all outgoings such
as interest and costs). The SMSF has 2 brothers as members, one is 65 and the other 55 (both with
equal member balances within the SMSF). The older brother decides that he wants to retire and
starts pulling some funds out of the SMSF as a pension payment (as he knows that reaching the age
of 65 is a ‘condition of release’).
The issue here is as follows:
• The net asset position of the SMSF is that each brother has $250,000 as a member balance.
• The SMSF generates $10,000 per year of excess cash.
• The minimum pension payment for 2016 for someone aged 65 is ‘5% of the net asset position
of their member balance’ (i.e. $12,500).
• As such, there is not enough free cash to meet the minimum pension payment requirement for
the older brother.
• Not meeting the minimum pension payment in a financial year is a compliance breach for SMSF
trustees and can result in personal fines and potentially result in your SMSF being deemed ‘noncompliant’
by the ATO (often resulting in the removal of all tax concessions that SMSFs enjoy).
How do you fix this? Not easily. The obvious answer is to sell the property. You would then have
plenty of liquid cash to meet this minimum payment. However, this isn’t usually the favoured
outcome, as the property market might be flat, or the other trustee may not want to sell.
The more common approach would be to get the younger trustee to make a non-concessional
contribution to the SMSF to get an extra $2,500 into the cash account of the SMSF, and make the
pension payment from this additional cash to the older member so he meets the minimum pension
requirement. It is important to point out that the older brother cannot make the contribution
to the fund as he is older than 65 and not working – therefore prohibited from making future
contributions to the SMSF.
Note: When you make a contribution to an SMSF with more than one member, that contribution
gets allocated to you from an accounting angle, however, the exact cash dollars do not – they go
into the asset pool. So, in the above example, the brothers owned 50% each before the additional
contribution was made. Once the younger brother made the additional contribution of $2,500,
the SMSF had a net asset pool of $502,500, and the younger brothers’ member entitlement would
grow to 50.24% of the pool of assets, with the older brother being diluted to 49.76%. So, it doesn’t
matter that the cash contribution was made by the younger brother and taken out by the older
brother as pension payment, so long as the numbers stack up then this is the easiest strategy to get
yourself out of this situation.
Just make sure you sort this out prior to June 30. If you leave it until after this, it will be too late. You
cannot back date a pension payment from the bank account.
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