Negative gearing in SMSF?

I am new to looking at SMSFs. I have read two conflicting versions of negative gearing an IP within an SMSF. One version says you can do it, it looks like this:

Rental income: $30k
Contributions received: $10k
Total: $40k
Less:
Interest: $30k
Other expenses: $10k
Net taxable income SMSF: $0

In other words, the IP would have lost $10k, so you contribute $10k (pre-tax from salary). This makes it equivalent to negative gearing in your own name. They say 'contribution tax' of 15% is misleading terminology, it's not a tax on contributions but rather a tax on the income of the fund (which in this case is zero).

The other version says losses on the IP could only be offset by other income from investments, not from contributions.

 

You can offset the loss from any type of taxable income including concessional contributions.

This assumes it is not in pension mode.

 

In theory I can't see why you can't negative gear in a SMSF. It's such a low tax environment I'm not sure it's entirely worth it to pursue intentionally. Also in your example you seem to be confusing assets and income and I'm not sure it makes sense, doesn't to my untrained eye.

Are contributions taken into consideration for net income? Or is the income generated from the investment of the contributions?

 

Negative gearing in a smsf is very ineffective due to the low tax rate of 0, 10 or 15%. On a $10K tax loss you will consume and lose the $10K of contributions all for a $1500 tax saving. Its a net $8500 loss.

Negative cashflows are a major mistake made by some who dont seek advice. Negative cashflows mean the SMSF will need contributions to sustain its cashflow. The fund will "burn" cash to sustain a loss making property and it wont change for a LONG time. The fund wont grow and the contributions are just consumed in the chase for a potential future CGT amount. A SMSF should ideally be positively geared. The idea is make as much income as you can and it is taxed at a low tax rate. That PLUS growth are the member benefits.

These sorts of funds are costly to operate and maintain through the fees (largely capped) plsus to consumption of contributions. We often see in 6 years or so the members tire of the losses and find that sort of property hasnt fared well in value anyway.

Rarely when a fund has multiple properties and multiple sources of taxed income neg gearing can make sense for the leverage but its still is illogical. If its being done as personal borrowing capacity is used up then its definately a poor strategy.

 

Part of the attraction is that I am at my borrowing limit outside super, and apparently those debts will not be considered in me now borrowing within an SMSF.

Regarding strategy (neg gear vs. positive cashflow properties). I can see how n.g. doesn't work as well given the combination of low fund tax rate and cap on contributions of $25k (which I am already over on compulsory 10%). It's still better than nothing though, and very interesting that it can indeed be done then as per my first example.

Personally, I never tire of paying annual $20k holding costs (with a 50% refund) and seeing annual $200k value gains from well-located growth properties. On reflection, I think it is even more important to hold a growth property inside an SMSF than outside it. As you've noted, the low rate actually points toward a positive cashflow property, however, the long term holding period and moreover, zero CGT (in pension phase), actually points to the biggest payoff being for growth.

 

IMO this crosses into the realm of the sole purpose test now. Ignoring all other issues the leverage to the fund that consumes contributions relies solely on single asset growth which is a punt. A highly leveraged punt. What is the risk management strategy if values fall ? Or even if they go flat ? OR the rental market avg rent drops ? The investment strategy and the non-diversaification is a matter that ATO has raised for auditors as a concern to consider. Lender policies partially try to limit high leverage like this as they know a fund that is burning contributions has NO other strategy if the property is vacant and it can happend for a variety of reasons. I saw a fund have a neighbour set fire to the property and it was uninsured. It created major issues for the non-recourse loan.and was a trigger for the mortgage..The recourse shifted to the members who had to draw new loans and it was a nightmare. It may magnify the cashburn very rapidly. It cant borrow, it can fund repayments and it could trigger a default or enforced sale.

Not sure where a "50% refund" comes from.

One of the smarter startegies for super is to target neutral gearing so contributions grow the fund on top of investment growth. Many factors to consider.

 

If you negatively hear a single asset in your smsf you are not in breach (by itself).

Adopting a strategy of chasing capital growth only is permitted provided you have considered the risks and liquidity. A good advisor to consider these risks is recommended but not compulsory.

It can be interpreted as a risky strategy by some - but risk is relative.

 

The neg gearing itself isnt so much the issue as neg gearing implies one loss offsets another taxable form of income. I always recommend the CASHFLOWS be considered. Negative cashflow means the fund needs contributions to merely maintain its investment. If that stop eg lost job the fund could be in real trouble. The fund cant borrow to make its repayments and other commitments.

A good example of the issue is a property that is cashflow neutral. It doesnt need contributions. That property for tax purpsoes could have QS deductiosn that create a loss which offset contributions saving tax. Excellent. It saves 15%. But you dont want neg gearing that is a consequence of negative cashflows because rental income is less than all costs. This is why the P&I amount must be considered, not just the deductible interest. Its often wise to reverse engineer the amount of the loan that gives neutral cashflows than it is to focus on a LVR for smsf property loans.