SMSF Property Investments Needs To Be Done Sooner

Article by: Damien Butler

Case study

In several of the SMSFs associated with LRBAs that we have seen, the member is at or approaching 50 years of age and has around $150,000 to $250,000 in super. Their ‘financial adviser’ has recommended they roll out of the current fund and establish an SMSF in order to purchase new residential real estate.
For the purpose of this case study, let’s make the following assumptions:

• Alan is 50 years old when he establishes an SMSF. He was born pre-1 July 1960. As such, his preservation age is 55.
• At that time, he had $250,000 in super.
• Alan is advised to roll that money into an SMSF and invest in a new residential property.
• The total cost of that property purchase is $500,000. Broken down as a $475,000 purchase price with stamp duty, legals and on-costs the remainder.
• Of the $475,000 purchase price, $40,000 is for fixtures and fittings; $235,000 for the building; and $200,000 for land. Assume an average depreciation rate of 20 per cent for fixtures and fittings and the 2.5 per cent per annum building allowance.
• Alan enters into an LRBA with a bank. The interest rate is 5.7 per cent per annum. For simplicity, I shall assume that it is interest-only, noting, however, that principal and interest may lead to greater cash outflows.
• Alan’s salary is $100,000 per year and he contributes $12,000, including SGC and salary sacrifice.
• Rental yield on the property is 3 per cent and costs associated with holding and maintaining the property, including rates, agent’s fees, repairs etc. are $3,500 per year. These are assumed to rise to $4,500 when Alan is 55 and to $5,000 when he is 60 years old.
• Each year, any additional cash flow is used to reduce the LRBA.
• Annual compliance costs and fund administration are $5,000.
• When Alan reaches age 55, the property is valued at $525,000 and when he is 60 its value is $575,000.

In accordance with the above assumptions, the following estimated cash flows arise. The cash flows are calculated at year one, when he was 50; when he is 55 and may wish to start a transition to retirement income stream (TTRIS); and when he is 60, looking to start a tax-free pension.

As can be seen from the above, should Alan wish to commence a TTRIS at age 55, there will be a funding shortfall of $6,667 per annum for his minimum pension payment. Further, the fund would have carried forward tax losses in the order of $40,034. Thus, the ability to pay a TTRIS is not possible. Even if it were, the potential that the carry forward tax losses are unutilised may mean that this strategy is not viable in any event.

Should Alan wish to switch on a tax-free pension from the age of 60, there is still a cash flow shortfall of $7,179 per annum. This makes it very difficult to move into pension phase, providing Alan with little option but to keep working for the foreseeable future. It is also worth noting that based on the above assumptions, this will be the first year that the fund generates taxable income in order to offset some of the tax losses carried forward. By the time Alan turns 60, the carried forward tax losses are around $45,000.