BORROWING USING SELF MANAGED

SUPERANNUATION FUNDS AND RELATED

UNIT TRUSTS
Overview

The changes made to the Superannuation Industry (Supervision) Act [SISA] in September 2007
meant that the trustees of SMSFs were able to borrow using instalment warrants in order to buy a
permissible asset for their fund. Many trustees saw this as a means to buy real property. However,
the products that have subsequently been released by the major banks in Australia that comply with
the legislation may have loan to value ratios or other necessary conditions that make the purchase
difficult if not impossible. Trustees may also use a related unit trust in order to meet their desire to
purchase a property while still meeting the borrowing restrictions of the SISA.

Strategy

Trust Deed

The first stage to this strategy is to ensure that the SMSFs trust deed allows an investment in a unit
trust. This may sound obvious to many however, it is necessary as many deeds are quite restrictive
in their rules regarding permissible investments.

Unit Trust

Next a unit trust is required to hold the property. Another important point is that the trust is a unit
trust as this is specifically mentioned in SIS Regulation 13.22B in order to comply with s. 71 (1)(j)(ii)
of the SISA in relation to in-house assets. (This is a complicated area of the law and it is not the point
of this paper to explain the in-house asset rules.)

Borrowing

Borrowing is prohibited by an SMSF under s.67 of the SISA unless under an instalment warrant
arrangement. The unit trust is also prohibited from borrowing and cannot offer the property as
security. It is necessary for the members of the SMSF to borrow independently of the unit trust and
the SMSF using other property as security for the loan. In the majority of cases the members use
their home as security for the borrowing.

Document Created Monday, 9 February 2009 Guardian Partners 2008-2009

www.guardianpartners.com.au
Structure

The SMSF and the members subscribe for units in the unit trust to give the unit trust the cash to buy
the property. The unit trust purchases the property and rents the property out on commercial terms.
The unit trust will distribute any profits to the unit holders in direct proportion to their holding. The
SMSF may decide to subscribe for more units in the unit trust in the future and the unit trust may
redeem units from the members (a capital gains tax event) thus changing the ownership proportions
and hence future profit distributions.

The strategy above has been simplified in order to explain the ability of a trustee to purchase a
property using the equity in the members home. Examples follows that illustrate how this strategy
could look.

Example 1 A Commercial Property

Peter and Jenny operate a successful design and architecture business and have been renting
premises for the past five years. Their lease is due for renewal and they have found larger
commercial premises that better suit their business needs and are looking at using their
superannuation fund to assist in purchasing a property that they believe will provide for their
retirement as well as accommodate their business until they retire.

Their superannuation balances total $150K and the premises are $600K (stamp duty and legals are
ignored for this example). They establish a unit trust and their SMSF subscribes for 150K units. Also
they obtain a loan from their bank for $450K using their home as security and then subscribe for
450K units in the trust. The trust now has enough to purchase the commercial property.

SMSF

Subscribes for 150K units

Unit Trust

Purchases commercial property

Peter & Jenny

Subscribe for 450K units

Bank lends money to

Peter and Jenny using
their home as security

Document Created Monday, 9 February 2009 Guardian Partners 2008-2009

www.guardianpartners.com.au
Peter and Jennys business enters into a commercial lease with the unit trust to rent the commercial
property as their business premises for $60K p.a. including all outgoings. The rent paid by the
business is deductible to the business and is income to the unit trust. Ignoring any other unit trust
deductions the net trust income is distributed as follows $15K to the super fund and $45K to Peter
and Jenny. This can be used to pay down the loan they have with the bank and the interest the bank
has charged them for the purpose of the investment in the unit trust is deductible to them
personally.

In addition Peter and Jenny have decided to enter into a salary sacrifice arrangement and are
contributing $50K each to their SMSF. After contributions tax this means the SMSF has $97.75K in
cash ($12.75K distribution and $85K from contributions). The super fund then subscribes for $97.75K
more units in the unit trust. Assume the property has not increased in value and the fund receives
97.75K units and that 97.75K units are also redeemed from Peter and Jenny who reduce their bank
loan further. The following table shows this.

Year 1st year SMSF Income

Distribution $15K

Contributions $100K

SMSF Assessable Income $115K

Less Income Tax ($17.25K)

Cash $97.75

The SMSF now has 247.75K units and Peter and Jenny have 352.25 units in the unit trust. In the
following year the proportion of the distribution made from the unit trust will follow the new
ownership proportions, that is, the SMSF will receive a $24.6K distribution while Peter and Jenny will
receive $35.4K. Following another successful year Peter and Jenny have again contributed $50K each
into super. Repeating this pattern quickly ensures that the property becomes wholly owned by the
SMSF by owning all the units in the unit trust and Peter and Jenny have repaid the bank and released
the security on their home.

Document Created Monday, 9 February 2009 Guardian Partners 2008-2009

www.guardianpartners.com.au
Year 1 2 3 4

SMSF net cash to $97K $105K $114K $124K

purchase more
units

New number of 247K 353K 468K 600K

units owned by
SMSF

Peter and Jennys 353K 247K 132K Nil

number of units

Peter and Jennys $314K $194K $69K Nil

loan remaining

The purpose of this table is to illustrate how the movements occur. Assumptions made are that
there is no capital increase in the value of the property, interest is at 5% p.a. and no expenses have
been included in either the SMSF or the unit trust and that the marginal tax rate of Peter and Jenny
is 30% after their salary sacrifice arrangements.

Example 2 A Residential Property

The following example will add a new level of complexity by taking into account some expenses for a
couple who would like to purchase a residential investment property.

Mario and Nicole have a combined $100K members balance in the SMSF and have found an
investment property for $350K (including stamp duty). After consulting with a number of real estate
agents they believe they can rent the property for $16K p.a. and the property has cash expenses of
$3K p.a. and non-cash deductions of $3K p.a.

After establishing a unit trust and using their home equity to borrow the required $250K the unit
trust purchases the residential property.

Document Created Monday, 9 February 2009 Guardian Partners 2008-2009

www.guardianpartners.com.au
 SMSF

Subscribes for 100K units

Unit Trust
Mario & Nicole
Purchases residential
Subscribe for 250K units investment property

Bank lends money to Mario

and Nicole using their home
as security

Mario and Nicole engage a property agent to secure them a tenant and enter into salary sacrifice
arrangements with their respective employers to increase their super contributions to $20K each
p.a.

First Year Unit Trust

Rental Income $16K

Less cash expense ($3K)

Less non-cash deductions ($3K)

Trust income $10K

Distribution to SMSF $2,857

Distribution to Mario and Nicole $7,143

Document Created Monday, 9 February 2009 Guardian Partners 2008-2009

www.guardianpartners.com.au
The distributions are made in proportion to the respective ownership proportions of the SMSF and
Mario and Nicole.

First Year SMSF Income

Distribution from Unit Trust $2,857

Contribution received $40,000

Less administrative expenses ($3,000)

Taxable Income $39,857

Less tax ($5,979)

Net cash position $33,878

The cash in the SMSF can be used to subscribe for more units in the unit trust and the unit trust can
redeem some units from Mario and Nicole.

First Year for Mario and Nicole

Distribution from Unit Trust $7,143

Less interest ($250K @ 5%) ($12,500)

Net income and additional cash required for loan interest ($5,357)

Negative gearing tax impact ($2,142)

As can be seen the principle of repayment is the same as Example 1. CGT applies on the redemption
of units.

Summary

Using a related unit trust to help purchase property for a SMSF may suit some people more than an
Instalment Warrant purchase due to loan to value ratios imposed by commercial lending institutions.
The structures are complex as are the tax issues, however, it does provide another means for the
SMSF trustees to achieve the goal of a property purchase.

Document Created Monday, 9 February 2009 Guardian Partners 2008-2009

www.guardianpartners.com.au
Disclaimer

This document contains general information and may constitute general advice. It does not take into
account any persons particular investment objectives, financial situation or individual needs. It
should not be relied upon as a substitute for financial or other specialist advice.

Before making any decisions on the basis of this information, you should consider the
appropriateness of its content having regard to your particular investment objectives, financial
situation or individual needs.

Opinions expressed constitute our judgement at the time of issue and are subject to change.

Document Created Monday, 9 February 2009 Guardian Partners 2008-2009

www.guardianpartners.com.au