March 19, 2013 by stirling

SMSF trustees will show even stronger interest in borrowing for direct property in their portfolios in 2013, according to Peter Townsend of Townsends Business and Corporate Lawyers.

Demand for advice on SMSF borrowing grew in 2012 but should grow further this year as investors look to move out of cash and are wary of the share market. Plus, he sees greater confidence by trustees in pursuing property plans inside superannuation portfolios rather than being personally held.

“We continue to notice a number of mistakes or poorly developed approaches commonly being made in the borrowing process by trustees and their accountants and advisers,” said Townsend.

Watch out for these traps:

Trap #1 – Failing to Understand Lender’s Requirements

Because SMSF lending is functionally different from ordinary property lending, SMSF advisers and their trustee clients cannot make any assumptions about what lenders are looking for from them.

Carefully check with the lender as to what requirements they have for SMSF limited recourse loans. Remember that banks and brokers are learning just as fast as everyone else is in this area. Trustees should expect closer scrutiny than ordinary property loans because the lender is offering limited recourse terms.

Will the lender require the member to agree to a particular contribution program to ensure sufficient money in the fund to meet any shortfall in income from the property?  If so has the trustee considered whether that program will be possible and advisable?

Will the lender require sign off by the fund’s accountant, financial planner and lawyer before proceeding?  Will the lender require personal guarantees?  Can the members provide guarantees and remain compliant?

Will the bank require that the SMSF trustee and or the holding trustee be companies?  Where the fund is buying business real estate from a related party, will the bank expect to see a full contract (arguing s.109 of SIS) rather than simply a transfer document.

Trap #2 – Failing to Appoint an SMSF Loan Champion

SMSF borrowing and purchasing can be complex. We have identified 15 main stages in a typical transaction that have to be successfully negotiated. Each stage in the lending process needs to be handled in the correct sequence.

There are many players who may be involved including (if an arm’s length purchase is being funded) the real estate agent, the vendor, the vendor’s solicitor, the fund’s conveyancing solicitor, the lender, the loan broker, the lender’s solicitor, the fund’s superannuation solicitor, the custodian, the fund’s accountant, the fund’s financial planner and the stamp duties office …twice. 

The process needs a champion – someone who drives the process on behalf of the fund and understands all of the issues.  An investment/compliance transaction of this kind will go seriously wrong unless someone takes complete control.  The property experts will ignore the investment/compliance issues and the investment/compliance experts will ignore the property issues.

Trap #3 – Not Paying the entire Purchase Price from the SMSF

Buying property sometimes requires quick responses and these can be fatal for SMSFs buying and using a loan. The stamp duties legislation in the various states can catch trustees if the good faith deposit is paid from their own pocket and not quickly reimbursed by the SMSF.

All the money must come from the fund or its lender. Further there must be a clear documentary trail showing this to be the case. If you suddenly realise that the purchase has been completed without complying with this rule then seek advice immediately.  A solution may be possible but time is of the essence.

Monies provided by the lender pursuant to the loan agreement with the SMSF Trustee are treated as being provided by the SMSF Trustee.

Trap #4 – Not Arranging the Stamping of the Holding Trust Deed

The holding trust deed must be stamped to ensure that any ultimate transfer from the holding trustee to the SMSF trustee attracts only nominal stamp duty. Further it must be stamped within the period allowed for stamping (generally either 2 or 3 months after first execution).

And even though the amount of duty may be nominal, tempting the fund to delay paying that duty, it makes sound, practical sense to have all documents stamped when the people and the financial records relating to the documents are readily available.

The documentary evidence could be very difficult, if not impossible, to find in, say, 10 years time when the loan is being repaid.  Double stamp duty could result.

Note that the holding trust deed cannot be stamped until after settlement of the purchase.  The duties authorities need confirmation that the settlement money only came from the fund (and its lender) and this confirmation cannot be provided until after settlement.

Trap #5 – The Lender as Holding Trustee

The idea that you can save money by having the lender act as the holding trustee in a related party loan to an SMSF is a fallacy.  It will result in a fundamental conflict of interest. SMSF trustees and their advisers don’t need the extra grief of having the ATO questioning if this arrangement is suitable and compliant.

The presence of that conflict (where the holding trustee is both the bare trustee for the fund and the lender to the fund) will undermine the ‘absolute entitlement’ of the SMSF.  This in turn could have at least land tax and CGT repercussions for the fund, not to mention undermining SIS compliance.  The arrangement should be avoided.

Call Stirling on 4261 5506 for more information