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SMSF-property-unit trust Vs warrants

Discussion in 'Superannuation, SMSF & Personal Insurance' started by Grace, 30th Dec, 2009.

  1. Grace

    Grace Member

    Joined:
    30th Dec, 2009
    Posts:
    7
    Location:
    sydney nsw
    Hi,

    Hoping someone can help with info

    I have a property unit trust. SMSF has 60% units. I hold the other 40 % units, using borrowed funds. I intend to, over time sell my units back to the trust and SMSF will purchase them.

    I am considering purchasing the next property using an installment warrants within the SMSF.

    I only intend to have cash and property in my SMSF.

    My goal is for these properties not to be sold but pass to children. Even perhaps to help them build a portfolio

    Q.What are the advantages between the both types of structure.

    I know CGT with units will be realized when sold back to trust. Where with warrants CGT won't be an real issue.

    My main concern is when is pension phase. I don't expect to need the SMSF pension as I have other super. The rent from properties may not cover the top pension rate. I do not want to have to sell.

    With the unit structure

    Q. Can the SMSF sell unit back to trust for cash. Then the SMSF has cash for pension. And I outside of fund pay cash to trust to purchase units. This could not be done with warrants

    Thanks
     
  2. Superman

    Superman Well-Known Member

    Joined:
    6th Nov, 2007
    Posts:
    343
    Location:
    Gold Coast, QLD
    Hi Grace,

    You have asked a couple of questions being:

    #1 Comparison of the advantages between owning property in a unit trust vs an instalment warrant arrangement

    #2 Can the SMSF redeem some of the units for cash to enable payment of a pension in the future?

    Unit Trust v. Instalment Warrant for holding property:


    a. Depending on which state the property is located in, the transfer of units to the SMSF will incur stamp duty / transfer duty (though not in Victoria) in additional to the realisation of CGT. In comparison if the instalment warrant for the property has been correct set up there will be no CGT or stamp duty on the transfer (when the loan is paid back in full and title transfers to the SMSF)

    b. Unless the unit trust was established pre 11 August 1999 you can only hold commercial property (and cash) within the unit trust. An instalment warrant can be used to hold both residential and commercial property (and any other investment allowable under SIS).

    c. Any property owned within the unit trust (unless pre 99) cannot be used as security for a loan. An instalment warrant enables the property to be used as security for a limited recourse loan only.

    d. You can borrow to fund the purchase of units in your own name or in the name of another entity (such as a family trust) provided you do not use the underlying property as security (I believe this is what you have done Grace?). You would have to use other equity / other property as security - which is likely a lot cheaper than the premium interests rates charged by banks on limited recourse loans. If you have the ability to borrow without utilising the target property as security, you can fund the loan to the SMSF yourself. This is called 'member funding' - and is typically significantly cheaper than bank funding. A combination of both can also be used with excess cash used to pay off the higher rate bank loan first.

    e. An unit trust is more liquid (but still very illiquid) than a directly owned property or one owned via an instalment warrant. You can sell and transfer pieces of the underlying property by selling and transferring the units - whereas an entire property is a very 'lumpy' asset.

    f. A unit trust must maintain separate accounts and prepare an income tax return hence incurring additional professional fees each year. An instalment warrant will simply add additional costs for the SMSF.

    g. There is a lot of variation between providers, however it is a safe bet to say that on average to establish an instalment warrant and completing the purchase of a property is more expensive though that structure compared to a unit trust.

    h. A unit trust can be structured to have different classes of units such as income and capital units. A SMSF is beneficially entitled to all income and capital gains on a property held via an instalment warrant. This distinction may be important for your second question.

    In summary you need to ask yourself the following to help you decide which structure is best for you:

    1. What type of property is being purchased?
    2. How will it be funded?
    3. Will there be stamp duty on future transfers of units?

    Personally, my opinion is that the preferred way to fund this type of purchase is to utilise a member funded instalment warrant which gives the taxation advantages of having the property entirely owned by the SMSF in one hit, without the premium interest rates charged by the banks on limited recourse loans.

    How to fund pension when minimum payment is more than fund cash flow?

    This is simply a cash flow issue. Firstly you can look at getting more cash into the SMSF - however this may be difficult because when you get to that ripe old age (75+) you won't be able to contribute.

    You may be able to have someone else (such as a younger family member) become a member of the SMSF and contribute - which would inject more cash to enable the payment of the pension (I am assuming when you are 85+ and the minimum is 10%?).

    The major downside here is that a portion of the assets of the SMSF (i.e. the property / units in property trust) will be used to support their member benefits - which will be a nightmare when you eventually leave this world - not to mention increased administration / actuarial certificates etc.

    You can get more cash into the SMSF by selling / redeeming some of the units in the unit trust. This is obviously not a preferred option.

    The second option is to reduce the minimum pension by changing how much of your member benefit is in the pension phase. Say if the SMSF has $1million in property, you are 85 years old (meaning 10% or $100k minimum pension) and $65k net cash flow you could elect to only have say $600k in pension with the remainder in accumulation phase. This would drop your minimum pension amount to $60k but mean you pay tax of 15% on the remaining 40% (or $400k of $1m).

    I previously mentioned that with a unit trust there is the possibility of having both income and capital units. You could theoretically use the income producing units to fund your pension, and the capital units to fund your accumulation account. Under this segregated approach the SMSF will still remain tax free provided it didn't have a capital gain (no capital gain means no taxable income applicable to the capital units = $0 tax).

    Another option is to look at a reserving strategy which could have a similar impact by reducing the forced minimum pension draw down as you reach your twilight years.

    You also mentioned passing on the properties to your children in the future. Assuming your children will be non-financially dependant adults when you die, they will have to receive a lump sum payment from your SMSF. This means they would each get cash from the sale of the properties, a % share of the properties and or a number of units in the unit trust(s). Payment of death benefits and the possible strategies around them is a whole other area and a little beyond the scope of your original questions.

    I hope this has provided some helpful information, however if I have just created a lot MORE questions, please let me know and I will do my best to clarify or elaborate.

    Also, due the possible complexity of your situation I highly suggest you seek specialist advice from an appropriately knowledgeable and qualified person. Please contact me and I would be happy to recommend someone in your area.

    Happy new year! :)
    SM
     
  3. Grace

    Grace Member

    Joined:
    30th Dec, 2009
    Posts:
    7
    Location:
    sydney nsw
    Hi SM,

    Thanks for the reply, I will try to give further information

    I understand A

    B. Unless the unit trust was established pre 11 August 1999 you can only hold commercial property (and cash) within the unit trust.
    I mightn't have explain the type of trust it is. Set up in 06 it owns a residential property.

    C property/units is secured against first property I got.... negative gear many years ago with small mortgage.

    D If you have the ability to borrow without utilising the target property as security, you can fund the loan to the SMSF yourself
    Interesting might look into this,but will have to borrow against first property

    Understand E

    Understand F

    Finding G the case, and bank managers really have trouble with this still trying to find one that really KNOWS what they are doing.

    H didn't know about this till later and happy the way it is..I think ???

    1. What type of property is being purchased?Residential
    2. How will it be funded?cash and borrowing
    3. Will there be stamp duty on future transfers of units?I suppose so

    Personally, my opinion is that the preferred way to fund this type of purchase is to utilise a member funded instalment warrant which gives the taxation advantages of having the property entirely owned by the SMSF in one hit, without the premium interest rates charged by the banks on limited recourse loans.

    Sounds good to me

    How to fund pension when minimum payment is more than fund cash flow?

    This is simply a cash flow issue. Firstly you can look at getting more cash into the SMSF - however this may be difficult because when you get to that ripe old age (75+) you won't be able to contribute.see what I mean,any cash will be to used to pay off mortgage

    You may be able to have someone else (such as a younger family member) become a member of the SMSF and contribute - which would inject more cash to enable the payment of the pension (I am assuming when you are 85+ and the minimum is 10%?). could cause a lots of problems

    You can get more cash into the SMSF by selling / redeeming some of the units in the unit trust. This is obviously not a preferred option. I know

    The second option is to reduce the minimum pension by changing how much of your member benefit is in the pension phase. Say if the SMSF has $1million in property, you are 85 years old (meaning 10% or $100k minimum pension) and $65k net cash flow you could elect to only have say $600k in pension with the remainder in accumulation phase. This would drop your minimum pension amount to $60k but mean you pay tax of 15% on the remaining 40% (or $400k of $1m).Interesting aren't you clever

    I previously mentioned that with a unit trust there is the possibility of having both income and capital units. You could theoretically use the income producing units to fund your pension, and the capital units to fund your accumulation account. Under this segregated approach the SMSF will still remain tax free provided it didn't have a capital gain (no capital gain means no taxable income applicable to the capital units = $0 tax).
    Can the trust be change now, or later, or it it too late

    Another option is to look at a reserving strategy which could have a similar impact by reducing the forced minimum pension draw down as you reach your twilight years.Don't really understand this

    You also mentioned passing on the properties to your children in the future. Assuming your children will be non-financially dependant adults when you die, they will have to receive a lump sum payment from your SMSF. This means they would each get cash from the sale of the properties, a % share of the properties and or a number of units in the unit trust(s). Payment of death benefits and the possible strategies around them is a whole other area and a little beyond the scope of your original questions.So units they can get as well as cash, but not the property brought with warrrants

    I hope this has provided some helpful information, however if I have just created a lot MORE questions, please let me know and I will do my best to clarify or elaborate.Thank you so much,I have been happy with the unit structure I think ??

    Cheers
     
  4. Superman

    Superman Well-Known Member

    Joined:
    6th Nov, 2007
    Posts:
    343
    Location:
    Gold Coast, QLD
    I need to amend this point as it is not correct :eek:.

    An SMSF can invest into a related unit trust (post 11/08/99) that owns residential property provided that:

    - there are no borrowings (in the unit trust)
    - the property is not used as security for a mortgage
    - the residential property is not leased / rented to a related party
    - the residential property was not purchased from a related party in the previous 3 years

    So Grace's situation is OK provided she has complied with the above.

    For the technically minded I have attached further information (PDF) and for everyone else I have attached a flowchart which determines whether the investment is OK.

    A little off topic - unrelated parties and unit trusts:
    Interesting to note that the ATO deems control to me more than 50% - not 50% exactly. This means two unrelated parties who each own 50% of the units could technically employ borrowings within a unit trust.

    This has been confirmed to me via other professionals who have obtained private rulings from the ATO - so I guess it is a little bit of hearsay, but it does make sense based on how the legislation is written. Obviously paid professional advice should be obtained before entering into such an arrangement.

    So who is a related party?

    A "related party'' of a superannuation fund means any of the following:

    • a member of the fund;

    • a Part 8 associate of a member;

    • a standard employer-sponsor of the fund; or

    • a Part 8 associate of a standard employer sponsor of the fund.

    So who is a Part 8 associate? - please refer to the other attached diagram.

    It comes down to a relatively common sense definition, meaning if you are related by blood or in business with someone, then they will be a related party. If they are simply an acquaintance they are probably unrelated.

    I hope this clarifies.
     

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