6 reasons why Super Gearing is better than Negative Gearing + Free Seminar tickets worth $55

Positive Gearing is a situation when return on asset is greater than cost of borrowing. Recent drop in interest rates combined with high rental return on residential property has created a window of opportunity for investors where they can purchase a positively geared property.

For how long this window will remain open is anybody's guess. Usually it takes about 6 to 9 months before everyone else also joins and then demand for property slowly crepes and saturates existing supply of available properties. Usually this sudden demand gets the developers off guard and new supply takes a year or more when new plans are lodged in council for approval. This sudden shortage triggers a property boom.

The above tested formulae works under perfect conditions; however, this time round, property boom may not be the same as of last decade. This time round, property boom may take an unprecedented shape due to short supply of money, higher unemployment rate and low housing affordability (prices are already high) but due to shortage of new release of land, especially in Sydney, next boom is eminent, WHEN is the question, perhaps US president Obama may have the answer with his 980 Billion stimulus package announced last Friday.

Why Negative Gearing is not a good idea

When you purchase property in your own name, you can claim the loss over rental income in your tax and receive a refund from ATO. However the loss after tax refund has to be funded from after tax salary, this means that it costs more to own a negatively geared property.

Further, when you sell the property after the boom, a large amount is paid to ATO when Capital Gain is derived even after 50% discount if property is held for 12 months or more.

Why Super Gearing is better than Negative Gearing

There are many reasons why property should be purchased using a gearing strategy within SMSF instead of outside of super, such as

1.      Compared to the previous boom - taxpayers now have more money in their superannuation funds due to 9% compulsory contributions of the past decade, hence there is enough money in super for a 30% required deposit;
2.      Superannuation Funds can now borrow under the new provisions introduced in September 2007, this was not possible in previous property boom;
3.      Any loss on gearing by the fund can be compensated by additional salary sacrificed contributions to the fund, which will pay no contribution tax, due to the loss of renting property within the super fund;
4.      When properties are sold in pension phase, there is no tax paid on Capital Gain by the super fund;
5.      If property is sold after 12 months in accumulation phase, the effective tax rate is only 10% after 1/3rd discount.
6.      Funding is available to superannuation funds with some lenders offering 70% LVR.

How to Purchase Shares in Instalments

A) Share Instalment Warrant

If you were to purchase shares under an instalment warrant arrangement, the issuer of the warrant e.g. Macquarie bank will borrow the money for you and hold the shares in trust till the Super Fund pays the remaining instalments. The bank will charge a fee for the service and charge a margin on the loan.

B) Property Instalment Warrant

The same formulae can be repeated for property, however creates new challenges for lenders because due to sluggishness of this asset class and its un-ability to be unitized (cannot sell a part of the property). Hence, the borrowers not only have few lenders but also face complex borrowing arrangements and higher transaction and borrowing cost.

One such loan is available from Westpac Bank up to 72% LVR, but requires their solicitors to review each transaction at the borrower's expense of approx $3,000 and the bank charges a 1.6% higher margin than a normal home loan margin. There is also an additional cost of $2000 (approx) to create an instalment warrant structure.

Further due the non-recourse requirement of SIS Act (Sec 67 (4A) of SISA) the bank also insists on personal guarantee from members of the fund. This personal guarantee document has been the centre of controversy and the ATO has specifically spoken critically of this arrangement, click here for more information.

C) Members who have equity in their own home

The controversy surrounding personal guarantee is due to the risk criteria of the bank. They want more than 28% equity in the property for which they are lending to secure their loan to the SMSF. Advisors or members of super funds who have taken out these loans now run the risk of Auditors lodging Contraventions reports to the ATO and the SMSF now risk of becoming non-compliant, as these loans are not strictly complying with SISA, specifically due to the recourse nature of personal guarantees from a related party, namely the members.

If auditors do not lodge contravention reports to ATO for these borrowings, they would themselves be in trouble with the ATO, because there is a question on the new Super Fund Income tax return form which specifically asks if the fund has borrowed.

Alternative to the above loan is the below arrangement, where the member borrows the money from a bank on full recourse using his own assets (own home or investment property) and then on-lends the money to the super fund on a non-recourse arrangement. This way, not only the cost of funding are kept down, the loan also complies t to the SISA, however, care should be taken whilst using this strategy as the member should charge the same amount interest from the SMSF that it is paying to the bank. The ATO has warned borrowers on this type of lending, CLICK HERE to read more.

D) A new type of borrowing by SMSF

The following picture has taken two years in the making, but now it is possible to borrow under this arrangement. Yes, it costs more (1.85% more than normal home loan rate + $4,500 entry cost) but suits those members of SMSF who want to get in the property market with their super fund and cash on the eminent property boom and those who do not own a home or have any enough equity in their own home to enter into the above arrangement.

To learn more on how the strategy works you can attend our seminar.