Exotic Investments and and Self Managed Superannuation Funds

Self Managed Superannuation Funds (SMSFs) are allowed to invest in exotic assets including shares property, art, antiques or even collections of rare coins or stamps.  The generous tax concessions available to Superannuation allows you to reduce your personal income tax and grow wealth in an environment in which you can more effectively manage capital gains tax.

Where to Start?
Fusion can help you decide if this strategy is the right fit for your current financial position and risk profile.  If it is, we establish a compliant SMSF with a trust deed that enables the Trustees to purchase investment assets. The SMSF must have an appropriate investment strategy drawn up to reflect the trustees’ investment approach.

What Type of Assets Can an SMSF Purchase?
The SMSF trustees can choose the asset they desire to invest in including, but not limited to, shares, property, art, antiques or even collections of rare coins or stamps.  Assets must be purchased from an unrelated vendor (arms length rule) and cannot be sold to the fund by a seller or entity related to the trustees or one of the SMSF members.

All assets must also pass the ‘sole-purpose test’’, an overriding super requirement that says any investments made by the fund must be made with the sole purpose of providing members with retirement benefits. The existing rules require you to have an appropriate investment strategy for the fund and to manage it according to that strategy.

Note: It is important to seek individual advice to determine if the asset you wish to purchase qualifies to be purchased as an investment asset

Can a SMSF Borrow to Invest?
An SMSF cannot borrow itself but in some cases is able to use an entity called a Bare Trust to borrow on it’s behalf. The Bare Trust holds the asset until it is fully paid for. It does this on behalf of the SMSF which is the beneficiary and ultimate owner.  When the loan is fully repaid, the SMSF is entitled to have the legal title transferred to it without incurring stamp duty.

The loan to purchase the asset is a limited recourse loan. Ie. secured only by the asset.  The lender can be an individual (including a fund member or relative) or a commercial lender. In the event of payment default or investment failure, the lender can repossess the asset but is not able to access any of the other assets within the SMSF or held personally by the trustees to recoup any loss.  The SMSF will receive any rental income and pay any loan interest or associated costs to maintain the asset.

Can I Enjoy the Asset Personally?
The most common answer to this question is NO, however the ATO has ruled that for an asset to be purchased by your SMSF and kept in your family home, it must be valued at less than 5% of the total fund value and be leased at a commercial rate for it to be classified as a legitimate investment. Otherwise, you are getting an immediate entitlement to the benefits of your super before you are entitled to it, resulting in a breach of the sole-purpose test.

Trustees are required to keep a written record of their decision making regarding where to store the assets.  They must also ensure that the assets are insured in the name of the fund within 7 days of acquisition and that they are not able to be used by any related party.  Artworks can be leased for display in a gallery as long as the gallery is not owned by a related party.

What Restrictions Apply?
SMSFs must comply with all relevant legislation and regulations. SMSFs must ensure that the level of investment in exotic assets is in line with the fund investment strategy, including diversification of assets, liquidity, and maximization of member returns in the fund. Trustees must ensure the fund has sufficient liquidity to meet its liabilities (such as for pension payments). The government has stipulated that super funds must have appropriate risk management measures in place and must understand the risks of investment.

What are the Risks to Consider?
Asset Selection – We recommend you seek professional advice for the best chance of purchasing the right asset at the right price to ensure the best security, income and long term growth.  Some assets are illiquid, that is, they can be difficult to convert back into cash quickly when you need it. You should also consider issues such as asset storage and insurance – shares can’t be stolen or damaged but exotic assets can.
Cash flow – With many investments there is a risk that the asset may be unable to generate an income for a period of time.  You need a cash flow forecast to ensure the SMSF will have sufficient cash flow from rent and super contributions to meet loan repayments and other expenses.  You should also have a sufficient cash buffer in the SMSF to allow for unexpected costs or events like loss of rental income.
Personal Risk – It is advised to take out income, life and TPD insurance so that in the event of you being unable to work, you will not have to worry about finding additional cash to fund your investment.
Legislation – Governments or the ATO may change the legislation in the future resulting in different tax concessions or charges applying.  Most legislative changes applying to investments in the past have provided existing investors with some exemptions.
Compliance – Having a fund that is setup or run incorrectly can result in substantial fines from the ATO.
Gearing – Any gearing or lending strategy allows you gain financial leverage, in this case it allows you to buy an asset without 100% equity offering the title to the asset as security for the lender.  As the asset value grows, your returns are multiplied by the gearing strategy, however if the asset value decreases, the gearing multiplies your losses.

What if I Want to Sell The Asset?
The SMSF trustees can sell the assets to any third party at a fair market price subject to repaying any mortgage loan or other amounts which may be outstanding.  Capital Gains Tax applies at a rate of 10% before retirement (33% CGT discount applies to the 15% tax rate inside Super for assets held longer than 12 months) or NIL if your SMSF is already in Retirement Phase.

What Tax Will I Pay on Income from the Asset in Retirement?
The beauty of holding income producing assets within an SMSF is that any income produced by the assets after age 60 when you are in retirement phase is 100% tax free.

In Summary
Investing in exotic assets through your SMSF may be worth considering:

•    If you seek advice to find the right assets with the potential to derive income
•    As a strategy for diversification of your investment portfolio
•    For assets with potential for a high capital gain

Superannuation is all about building assets to take into retirement improving your financial security.  For full details of the SMSF investment rules, visit www.ato.gov.au and look for the super pages.

For more information, contact your Fusion advisor on 1800 387 466

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