How new super rules will affect DIY funds’ property investment

Confusion over new super rules is stressing even the most seasoned property holders.

DIY funds must get a good grip on how the new super rules will affect property investment.

In the whirlwind of confusion following the government’s latest changes to superannuation, investors who have or plan to have property in their super funds have been sidelined.

Yet a proper understanding of the new rules and how they relate to property is going to be crucial. It’s not an exaggeration to say this has been one of the hottest areas of investing in recent years: borrowing by DIY super funds for property has ballooned from just $1.4 billion five years ago to more than $22bn today.

Part of the problem may be that these funds see themselves as property investors as opposed to active DIY super operators.

But here’s the catch: the successful use of super funds will now be as much about understanding the new terms of super as it is about the mechanics of any underlying investment.

With the latest changes this is more true than ever before. The system is now wildly over-engineered and falling foul of new rules will change your numbers. Having said that, investors may also find themselves making changes with their property portfolio that might be completely unnecessary.

Earlier this week I hosted a special live Q+A at www.theaustralian.com.au (we run these sessions for subscribers every Wednesday at 12.15pm) and the range of questions on property and super revealed a level of discomfort and perplexity that really is alarming when you consider property can be the biggest single asset in some funds.

There are a handful of major factors with which every investor should get familiar if they want to optimise the prospects for their property and their super.

Here are some of the main emerging issues:

Should I sell?

Some investors believe they will need to sell property because if they are planning to kick off a pension any time after July 1 next year, the new cap for retirement funds (from which you can draw tax-free income) will be $1.6 million.

What many people don’t realise is that you can quite simply lop off the excess amount and reallocate this amount outside the “capped fund”.

For instance, if you fully own a property worth $1.8m and you wish that to be included as an asset to fund your super, then it is $200,000 over the cap.

It is not a binary situation; there is an alternative to selling the property or exceeding the cap. You can reallocate the excess $200,000 into your accumulation account and only that segment will be taxable.

Hitting pension cap

There appears to be quite a few investors who are worried that a property they control will exceed the cap in value. But the rules apply to your “net assets”. Again taking the $1.8m example, if you have a mortgage equal to 50 per cent of that property, ie., $900,000, then your net asset figure in relation to your super total will be, in most cases, $900,000.

In other words, what matters is the equity you have in the property, so here the investor is well under the cap.

Taxable income

A number of investors appear to be concerned that if they exceed the cap (that is assuming they keep the money inside the super system, in accumulation rather than retirement account) the tax will be 15 per cent on the amount by which they exceed the cap. Using the same $1.8m property as an example, the tax is not 15 per cent on the excess on the cap ($200,000); rather, it is 15 per cent on the earnings you can make on the excess — maybe this would be, say, 5 per cent — so 5 per cent on $200,000 is $10,000 and 15 per cent on that is $1500 tax due.

Lack of time

As property is such a notoriously illiquid asset — it is slow to buy and sell and involves very large amounts of money — investors are very concerned they will not have time left in their working lives to either arrange property holdings as they wish, or to make the super contributions they will need to complete key deals.

It is worth remembering that you can always put in three year’s worth of contributions to superannuation in any given financial year. In the remaining months between now and June 30 2017 this total depends on your age: for those under 50 it is (concessional) $30,000 plus (non-concessional) $180,000 times three — $570,000; for those over 50 this is $575,000, as the concessional rises to $35,000 and then $180,000 times three.

From July 1 next year, it will be still possible to put three year’s worth of contributions together. The only difference is that the total allowed drops.

Regardless of age it will come to $325,000 for everyone (there will be flat $25,000 concessional limit and you could put that together with three times your non-concessional allowance (which is to be cut to $100,000). The post- tax contribution rules are exceptionally difficult and we still don’t have final legislation details on how it will all work, so be very careful here.

Broadly, there have not been any specific changes to property in the new super rules — rather there are a range of indirect consequences such as those outlined above that are highly relevant.

One more thing: I’m always surprised at the perennial questions which never stop coming up in this area:

Can you have an overseas property in your super fund? Yes, but it is a lot of trouble.

Can you use your super fund just for a deposit and split the ownership between the fund and you personally — where you take out a mortgage and get the benefits of negative gearing? Yes, a unit trust structure is perfect for this.

Can you live in the house that is bought with your super fund? No, it must be strictly held for the sole purpose of improving your super. It must be exclusively a rental property. In fact the ATO has a unit that rolls through neighbourhoods spying on you … only kidding … I hope!