|
Deeds Created in 20 Minutes 24/7
EMAILED INSTANTLY |
What is a Property
Installment Warrant (PIW)?
Property
Installment warrant (PIW) provides SMSF the opportunity to release their
potential by investing directly into one of Australia's favorite asset classes,
residential property.
PIW
can achieve long term exposure to residential property for SMSF's with all
property management and administration arranged by the trustees. It is a
leverage solution with a limited recourse without (in some cases) the need
for personal guarantees from trustees.
It
is a structure where the security trustee related to the SMSF trustee acquires the property and
the choice of property can go as close to the trustees next door house, as long as you
and none of your relatives live in it.
How PIW work
SMSF
Trustees choose a property and arrange finance of balance amount needed to
complete the sale. On settlement the security trustee (of a bear
trust) holds the property in trust for the benefit of the SMSF. Any local
property manager can manage the property for SMSF trustees. The rent is paid directly
to the SMSF bank account. Members and / or member's employers contribute to the
SMSF, deductible (concessional) contributions and these contributions are then
used to repay interest and principal on loan to the lender.
If
property is young, there could be depreciation expense which can be claimed by
the trustee in addition to negative gearing within the fund. This negative
income or loss in the fund can provide a shelter to the new extra (salary
sacrifice) contributions which otherwise would be taxed at the member.
Rent
is deposited in the SMSF bank account along with contributions and other income
of the fund, interest is paid from the fund's bank account. Most lenders allow
Principal plus interest loans, that means, that any extra contributions or any other
income of the fund can help to reduce the loan amount.
Negative Gearing VS Super
Gearing
1. Tax Rate
Due
to 100% tax deduction available to an investor via super gearing compared to
only marginal tax rate deduction under negative gearing means that any tax rate
of the investor above 15% (tax rate of super funds), super gearing will give a
better tax result. That means that any investor whose income is over $6000 or if
you take low income tax rebate into account, any taxpayer who is paying tax,
15% plus 1.5% medicare levy must first think of super gearing before
initializing negative gearing strategy.
2. Cost of ownership
In
negative gearing, there is a cost of property ownership after the tax refund,
this cost is also known as "annual contribution". This annual contribution is
paid mostly monthly to the bank to hold the property by the owner. If a PAYG
variation is in place, this cost is net cost of property ownership. The
investor hopes that property value must rise by this minimum amount, so that he
comes out even on the deal.
For
example if the net cash loss on property is $15,000 and the potential refund is
say $5,000 (assuming tax rate of 33%), the balance cost of $10,000 is paid by
the investor AFTER TAX.
That
means the investor has to earn $15,000, then pay the tax of $5,000 and then pay
the $10,000 annual contribution (mostly to the bank). Hence, annual
contribution or "cost to ownership" is $15,000 and not $10,000! This is perhaps
the only reason why ATO will never ban Negative Gearing.
Please
also remember that property investor's loss of $10,000 is bank's profit and
treasury takes a sweet cut of another 30% income tax on their profits.
To
conclude, the more the negatively geared properties are out there, the better
it is for ATO, banks, land tax office, councils, tenants etc. The only loser is
the property investor. Further, if the property values do not beat the annual
contribution (of $15,000 in our above example), it is a double whammy for the
owner, as he not only loses annual contribution each year his building depreciates over time. You can see the pain of many investors, as property
values have been stagnant, in many states since 2003.
Please
note depreciation is added back at the time of sale of property, hence, it is
only a timing difference but due to 50% discount at the time of sale, only half of the benefit
should be counted towards any personal calculation on cost benefit analysis.
Not
many accountants / advisors understand this cost BEFORE TAX concept and
continue to encourage high income earners Negative gearing strategies.
3. Capital Gain Tax
At
exit time, when negatively geared property is sold it usually results in the
investor paying a huge amount in capital gain tax, whilst in super gearing, if
the member is in pension phase, no tax is paid because funds paying a pension
do not pay any tax on income or capital gain.
If
the property is not sold and kept for investment income, namely rent, please
note that all incomes above the tax free threshold amount of $6,000 is taxable
even if the investor is over 65 years old, however, low income rebate, Senior
Australian Tax Offset are available. But if the retirement strategy is to have 3 or 4
properties outside of super and If rents go up - it could mean that investor pays tax till death!
In
a recent retirement survey it was pointed out that a couple would need $46,500
income each year for a comfortable retirement. For this comfortable lifestyle at least rental income of $54,000 would have to
be earned pre-tax, however, if the same property was owned by a SMSF, pensioners
would need to earn only $46,500 as all income stream paid to a 60 year old
pensioner are tax free. If one lives up to 80 years and if all assets were in SMSF there is a potential tax saving of $7,500
each year which amounts to $150,000 in a lifetime or more, if rents rise over this 20
year period.
Further,
if property is not sold and handed down to the next generation, kids could be
subject to capital gain tax as they acquire the cost base of the parents. Please
seek legal advice on this matter.
ZERO Capital Gain tax property
strategy - on inheritance
Australians
are now living longer and it is common for us to wait till we are 55 years old to
get an inheritance from our parents. If property is held in super by our parents
who are in pension phase, they can now sell their property to our super fund
without paying any tax. 
If we are in pension phase in our own fund, no tax will be paid on income or future sale to our kids super fund.
This means no tax is paid on rental income or capital gains EVER!
Property can move from one generation to the
next forever.
Why we should invest in PIW
- Choose your own
property in your SMSF, instead of purchasing a property managed fund.
-
Any
contribution, such as salary sacrifice or personal concessional contribution,
which could be taxed at the members Individual tax rate of 46.5% (or 31.5% if
income is below $80,000) in the current financial year will pay Nil tax to the
extent of the interest amount on PIW plus depreciation of property within SMSF.
- Gearing in SMSF
helps to magnify SMSF fund balance, if property values increase over time.
Please note that there are no RBL's, which means that the member can accumulate
as much balance as they want in their super fund.
- Typically we should own our home and funds in Super and have no other assets.
Potential Risks
-
Costs associated
with entering into a PIW transaction.
- Property which
the members choose can reduce in value over time.
- Interest rate
can go up over time which makes gearing becomes very expensive.
- Rental income
can reduce over time, which can result in re-possession of property if interest
is not paid to the lender on time
- If the member
cannot meet the shortfall, of regular interest over rent via new contributions,
this is possible in a situation, where the member loses his / her job, property
can be re-possessed by the lender for non-payment of interest.
- There is a
maximum of $50,000 which can be contributed concessional if a person is less
than 50 years old and a maximum of $100,000 if the member is over 50 years old
up to year 2012, which means if a large loan is taken by SMSF, it will take
some years to pay off the loan.
Why PIW are not yet popular?
History
When
amendment to Section 67(4A) and to related Section 71 of SIS Act was made in
September 2007, there was a huge excitement from all so called experts as they
were coming to grips with how the legislation has to be interpreted and how
SMSF trustees can benefit from the new legislation.
The
initial reaction was that the legislators (writers) have made a mistake in
drafting the legislation, by allowing any type of installment warrants within
SMSF. Originally, the previous government had promised to amend the SIS Act to
allow traditional installment warrant investment such as T3 etc. Some experts
thought, by error, drafters have now allowed the trustees to create their own
PIW and that is "treasury's mistake" and would be corrected by the new government
in their first budget.
Senator
Nick Sherry did nothing in his 1st budget, hopefully, it is safe to assume that the new government will not tinker with this new rule.
It
took many months for lenders (and their solicitors) to understand the new
legislation. Their task was to write a "loan document" which looks like a
"Sub-prime loan" a "non-recourse loan" that complies to the new legislation but without
any capital loss (mortgagee loss) to the lender yet keep the LVR low so that the
new loan product appeals to the masses. The
solution which they came up with is now the current topic of disscussion: "personal guarantee from the members of the fund".
Lending Products
Some
lenders such as Macquarie, Bank of Scotland and structured product expert
Babcook and Brown and Seiza Capital were the first one's off the rank, later
Westpac and NAB introduced their products and the writer is aware that CBA is
about to launch their product. Some lenders only offered their loan to sell
their property development ventures, which means loan was available only if the
trustee purchased their property.
Personal Guarantee
Those
lenders who did not seek personal guarantee, such as Macquarie and Calliva
(bank of Scotland) demanded high deposit from the SMSF purchaser and high LVR. That
meant that, if the trustee wanted to purchase a property in a capital city for
about say $450,000, they had to invest at least $200,000 of their own money
including stamp duty and costs.
Plus
they had to demonstrate that either the rental income would be high enough or
their compulsory contribution would be sufficient to meet interest shortfalls.
Due to the present borrowing climate, interest rates from these lenders are over 11.5% to cover
the insurance costs of a non-recourse loan.
Non Personal Guarantee
lenders
Imagine
interest on loan of $27,500 (11% of $250,000 on a $450,000 property) plus other
costs of say $2500 like council rate, land tax etc, the rental income of the property has to be
at least $30,000 or 6.7% to be neutrally geared, or the fund has to have other income or members have to contribute to make up the diffirence.
The
Fund must pay interest on the property, as the loan cannot be
capitalized due to provisions of the Section 67 (4A) and if rental income
is not enough and if the fund has no other income, new contributions or un-avoidable, hence retirees who cannot contribute should not consider PIW as an investment strategy!.
In
recent times, rents have gone up. But current gross rental yields on
residential property are still at only 4.5% (or $20,250) which means that
lenders have to ensure that the balance interest of $9750 has to be funded from
compulsory super. Which means that the lender has to ensure that all members are in regular jobs and earn at least
$108,333 so that (at least) the 9 % compulsory employer superannuation contributions can cover
the interest and expenses cost over the rental income.
Further,
a super fund to have a deposit of $200,000, assuming with no diversification, is a big ask from the massess, at least for some time, as 9% compulsary super kicked in only three years back.
Personal Guarantee Lenders
Those
lenders who take personal guarantees from members of SMSF have designed their
product despite the tax office's tax alert and their "concern" over these guarantees.
ATO contention is that personal guarantee defeats the intended non-recourse
loan purpose of the legislation. Click here
to read ATO's tax alert
Interestingly,
these lenders, due to extra comfort of questionable personal guarantees, offer lower
LVR's, as low as 78% (only 22% deposit plus costs like stamp duty is required
from SMSF). Their interest rate is lower (closer to 10.5%) however still 1%
higher than a normal home loan product.
In
our example above, if same property is purchased by this loan, SMSF would
require about $140,000 to include 28% deposit, stamp duty and costs. A big ask
for the masses but achievable for those couples who have been working on
reasonable good income for over 10 years.
If
350,000 is borrowed, trustees will need $39,250 ($36,750 for interest @ 10.5% and
$2500 for costs such as council rates, repairs etc) and at current 4.5% rental
yield will have a shortfall of $19,000 interest which has to be funded from
compulsory or salary sacrificice super. The lender has to ensure that all
members are in regular jobs and earn at least a whopping $211,111 for
compulsory 9% super. This could be a big ask from the masses.
Where is the knowledge?
Another
reason why PIW are not popular is because lack of knowledge on the product
among the various players. Traditionally property is sold by real estate agents
and shares by financial planners. PIW is a synthetic financial product.
Real
estate agents do not usually come from academic background and for them to
understand the product and then explain it to the masses can be difficult. Advice
from a suburbia accountant who does not specialize in super can be risky as the
fund could loose its complying status if the structure is not put together
properly.
For
some Trustees, it could be a complicated structure to understand, other PIW
issues are:
- The trust deed
should allow installment warrant and personal indemnity clauses
- Investment
Strategy of the fund should allow the investment and borrowing
- Transactions
costs of setting up the structure could blow up
- Borrowing costs
- interest rate premium over normal borrowing rate.
- Risk involved in
making an investment and their likely return in regard to overall investment
objective of the fund
- Inability of the
fund making minimum pension payments where compulsory interest payment has to
paid
Profile of PIW SMSF
-
Clearly only those
trustees who have at least $400,000 for 50% diversity in direct property should
consider this type of investment; Or
- Where the rental
return on property is very close to interest payment, in other words where
rental on property is as much as interest cost. In our example above $39,250
rent income results in 8.7% rate of return on $450,000 property. These rents
are achievable in some commercial properties but difficult in residential
property in the current climate.(Please note, growth in commercially property
value is not historically as much as residential property and vacancy rates are
much higher); Or
- The value of
property is low. For example if value of property is only, say $200,000 a 35%
equity contribution from the fund is only $70,000, which is do' able for most
funds. Further the shortfall of interest over rent is so low that it can be
financed from a low (salary) 9% compulsory super contributions; Or
- Where members of
a SMSF are a couple on high income where each member can safely contribute a
maximum concessional $50,000 each year to pay any shortfall of interest over
rent.
A
real estate agent has contacted us to sell some brand new tenanted two bedroom
apartments in Guildford Sydney NSW  the units are for sale for $279,000 and the current
rent is $345 per week.
Should you want more details on these units, please email us on sales@trustdeed.com.au
|
|
www.trustdeed.com.au provides online service for creating, storing & managing legal documents for Companies and Trust deeds for SMSF, Family, Unit & Hybrid Trusts, click here for more information.
 New / Update SMSF Trust Deeds cost only $110 and can be created in 20 minutes, Trust Deeds are emailed instantly!
|
|
FIRST TRUST DEED FREE |
if you are an advisor, financial planner, accountant or a solicitor, we can offer you to create one trust deed on our system for free. This offer is valid provided you purchase 10 or more new SMSF deeds or update 10 SMSF trust deeds for your clients. To claim your first free trust deed, first register on our website www.trustdeed.com.au and phone our office on 02 9638 2807 for a promotional code.
If want to communicate with your clients, advising them the need & advantages to update their trust deed, click here to download a pro-forma letter to your clients.
|
| remeber you can create a SMSF trust deed at any time 24 / 7 |
|
www.trustdeed.com.au goes on live help
If you are an advisor and use our website for your clients SMSF  Trust Deed. You now have access to SMSF Specialist Advisor who will answer all your technical questions online for you. Simply click the button above and start chat.
New or update your existing SMSF Trust Deed for $110 You can keep the trust deed up to date for the next five years for only $165.
Our SMSF trust deed has been prepared with input from accountants who have over two decades of experience in setting up structures for their clients and have combined knowledge of auditing and lodging tax returns for more then 2000 SMSF's, their practical experience is an invaluable contribution.
For further questions on our trust deed, ring 02 9638 2807 or email sales@trustdeed.com.au |
| |
Our Website has complete Document manager for all future downloads
We are the only online SMSF Trust Deed providers where you can purchase a Trust Deed 24/7 for $110
It takes only Less then 20 minutes to register and build a SMSF Deed.
|
|
| Phone 02 9638 2807 or visit www.trustdeed.com.au |
|
This email is sent by:
Sales Team
www.trustdeed.com.au
Deed Dot Com Dot Au Pty Ltd
P 02 9638 2807 F 02 9838 3060
Unit 4, 287 Victoria Road, Quantum Corporate Park NSW 2116
PO Box 1010 Dundas NSW 2117
| |
|
Click here for our previous newsletters
 Live Help
|
 |
| HOW IT WORKS |
|
|
Additions to our Website
Our News
|
5th June 08 :
Online Account Based Pension Documents
April08 :
Launched Unit Trust Deed
25th April 08 :
Launched Stationery Shopping Cart
Future Plans
1st October 08 :
Online Company Formation
Introduction Price $404 Incl.
ASIC Fees
1st November 08 :
Online Hybrid Trust
1st Decmber 08:
Development of SMSF Tools
- Change of Name
- Adding Member
- Deleting Member
- Audit Programme
- Loan Agreement
- Lease Agreement
|
|
|
