Tax Tip 225: SMSFs and Negative Gearing

Tax Tip 225 SMSFs Negative Gearing


Not many realise but a SMSF can negative gear property, and even shares potentially.


It works the same way inside a SMSF as outside. Any loss from an investment can reduce the taxable income of the fund which saves tax on that income.


Example

A SMSF has a property with a $15,000 loss after all expenses are taken into account.

The member of the fund contributes $20,000 into the fund in the form of compulsory employer contributions. This is normally taxed at 15% which would be about $3,000 in tax.

But with the loss from the property the income of the fund becomes $5,000 (-$15,000 + $20,000 = $5,000).

The tax on $5,000 would be $750.

So having the property would be saving the fund $2,250 in tax in that year.


Note that I am not suggesting that I think property in a SMSF is a good investment.


Originally Posted on structuring website 12 Jul 2019
SMSFs Negative Gearing - The Structuring Blog

 

The low tax rate can mean that neg gearing has minor "benefits". ie a 15% MAXIMUM tax rate. v's personal marginal rates of 34-47% for most taxpayers. This should be a warning sign that its not the best structure for any negative gearing environment. I would go as far as suggesting negative gearing in a SMSF is a poor structuring solution for tax purposes. It can cause funds to consume cash and go backwards leaving the CGT growth to one side. SMSFs are a low tax rate environment. Low tax rates fit well with income not losses.

One of the strategies often ignored by eligible taxpayers that can avoid this matter is a different approach. If there is suitable equity in property etc OUTSIDE super it may be possible to structure a ungeared unit trust. Both the taxpayers and a fund can then each buy units in the trust. The SMSF uses cash and the taxpayers use borrowed money. The trust buys a property. Each unitholder gets a share of the trust income BUT the taxpayers who borrowed can negative gear at their marginal tax rate. The SMSF pays tax on its share of income at 15%, perhaps even 0% in some cases. Benefits of this structure include:
- Low tax rate AND ALSO Neg gearing at a taxpayers personal marginal tax rate. Its akin to some of the smartest tax schemes but its 100% legal
- Opportunity in some states to change the % interest in the trust and not trigger stamp duty. A longer term strategy to guide the SMSF towards 100% interest in property is possible. Yes it comes with CGT costs but this can be progressively managed. Throw in deductible super contributions for some taxpayers and it can fund the change of ownership and also negatively gear the change of ownership at the same time. A triple dip tax benefit !!!
- A true pre-retirement phase strategy
- A extra land tax threshold v's individuals
- Costs are often low v's smsf loan in terms of fees and rates. OO rates of 3% vs SMSF rates 6.10% (comparison rate)
- The SMSF basically funds the deposits and oncosts. It funds part of the deal.

Some poorly experienced tax advisers see this structure as a concern. I have seen many been poorly advised that its prohibited. Its is not. Its a legitimate strategy BUT not all people can meet the rigorous rules. I come back to my earlier comment. If there is suitable equity in property OUTSIDE super it may be possible.

It may also be an alternative to a related party loan. Why confront the complex and costly problem when it may be avoided and give a tax benefit ?

The structure is a little complex and its important its well supervised for legal and financial and tax purposes. Any flaw on establishment OR after establishment may render it as a breach. But this isnt that onerous.

Borrowing for the potential gain alone while incurring losses may be a poor financial strategy especially where the horizons to member needs is not seeking this degree of risk.