Case Study 3

John is 45 years old and the proprietor of a successful small business. He purchased his business premises a few years ago for $450,000; it is currently valued at $550,000. The debt on the property is $200,000 and the rental proceeds are now greater than the deductions. His personal assets include a home valued at $800,000 (with $250,000 owing on it) and he has $350,000 in super. John feels that he is not getting ahead as he has owed the same amount on his home for three years now. How can his assets be restructured to improve his current position and help him achieve his goal of retiring at age 60?

Since the 'borrowing in super' rules came into effect on 24^th September 2007, super funds have been allowed to borrow and acquire commercial or residential investment property. John can set up a Self Managed Super Fund and roll his existing super into it. Using a combination of the $350,000 in his SMSF and external borrowings, his fund can purchase the commercial property from him and hold it on trust in the SMSF.

Stamp duty and legal costs amount to $50,000 so the SMSF borrows $300,000 to complete the transaction. As the vendor of the business property, John receives the sale proceeds of $550,000 and uses it to pay back the existing loan ($200,000) and extinguish the non-deductible debt on his home ($250,000). The sale of the property has resulted in a $50,000 capital gain after allowing for the original stamp duty and other costs.  John’s taxable gain is $25,000 (after the 50% rule) and this can be offset by a $25,000 concessional contribution to super, leaving him with $75,000 in the bank.

Here is the before and after snapshot;

*Super balance: $350,000 initial + $600,000 property + $21,250 contribution (after cont. tax) - $300,000 allocated to property purchase = $671,250

        BENEFITS

• If it would take John 15 years (until retirement) to pay off his home loan then the strategy will save him a substantial amount of interest.   Assuming an interest rate of 7%, he will be saving $154,472 in interest.
• Removal of non-deductible debt on the home
• The business property was previously and is currently positively geared. Holding it inside the super fund will mean the surplus income is subject to a 15% tax rate instead of John’s marginal tax rate. Assuming a 5% growth rate, 4% net rental return, 7.5% interest rate, and an annual income of $80,000, between now and retirement the amount of income tax saved is $42,839.
• If the property is retained until he is 60 (retirement goal) then sold once the super is converted to pension phase, there will be no CGT payable. Assuming a growth rate of 5%, the property would be worth $1,143,410 meaning he avoids having to pay tax on a capital gain of $543,410 ($271,705 after 50% rule). Assuming his business grows over the next 15+ years, when he sells it he will use all of the small business CGT concessions, leaving him with no avenue to offset the capital gain payable on the sale of the property.
•  If the property is retained after retirement, there will be 0% income tax and 0% capital gains tax payable in his pension fund.
• By making deductible contributions to the SMSF, John can use funds that have been taxed at 15% (contributions tax rate) instead of his marginal tax rate to further accelerate the time in which the loan is paid off

The strategy above illustrates how John can save hundreds of thousands of dollars in interest and tax between now and retirement. The end benefit is the attainment of his retirement goals by age 60.

Where an individual does not require access to funds prior to their preservation age, they are frequently better off holding assets inside super. 

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