Purchasing medical consulting rooms (or a partial interest in consulting rooms) is a common strategy for many specialists as they build their Private Practice. The speciality, location and size of the medical group may influence the decision to invest in a real estate asset in conjunction with running a medical services business.
You may have heard of the benefits of using a Self Managed Superannuation Fund (SMSF) to purchase real estate, however the rules governing this approach can cause considerable confusion.
Why consider a SMSF?
Superannuation is broadly taxed at 15% while you are still working and potentially taxed at 0% in retirement based on age. When purchasing consulting rooms, this has the potential to provide significant tax benefits over time when compared to other ownership options if you have a long-term outlook, sufficient funds within superannuation and the ability to make contributions to the SMSF.
A SMSF is one of the few superannuation structures that allows the purchase of direct property by the trustee. Typically a SMSF is unable to purchase or rent property from a related party (eg from you personally or a related trust), however there is an exemption when purchasing or leasing property from a related party if the property is considered a “business real property”. Medical rooms would normally be classified as business real property, thereby making a SMSF a viable ownership option.
Investment strategy first!
Before any investment decisions are made, it is a legal requirement that you (as a SMSF trustee) consider your investment strategy. Your strategy should include details such as:
- how much exposure you would like to the property market
- the form of exposure
- how appropriate it is for your current circumstances
A well-diversified portfolio is essential to provide income for retirement and spread investment risk so that any single asset class, such as a property, does not dominate your SMSF risk and returns.
With the above in mind, let’s step through the potential options for owning rooms via a SMSF.
Option 1 – SMSF acquires rooms outright
A SMSF that has cash (or the SMSF members have the ability to make large initial contributions) purchases the rooms outright. This is the simplest form of ownership as the SMSF will:
- Have all ownership rights to the rooms
- Can lease out rooms to a related party (i.e. medical services trust) on commercial terms
Important points to consider:
- Rooms needs to be registered in the name of the SMSF trustee
- All rent to be paid into the SMSF bank account
- All expenses need to be deducted from the SMSF bank account
- The rooms can’t be used as security for other real estate (mortgage, caveats etc)
Option 2 – Use a non-geared unit trust
If Option 1 does not represent a viable solution due to the value of consulting rooms being higher than the value of your SMSF (including the value of additional contributions), then using a non-geared unit trust may provide a solution whereby a SMSF and a related party hold units in a private unit trust (“property trust”).
While this is a more complicated method of ownership it allows the SMSF to:
- Initially purchase a part interest in the rooms alongside another entity (normally a investment or family trust)
- Gradually increase the SMSF’s ownership in the rooms over time by buying units in the property trust from the other related entity
- Maintain separation of rent and expenses, as these transactions are maintained within the property trust
Important points to consider:
- Rooms need to be registered in the name of the trustee of the property trust
- All rents to be paid into the property trust bank account
- All expenses need to be deducted from the property trust bank account
- At the end of the financial year, the net income from the rooms is determined and paid to the unit holders (including the SMSF’s interest)
- The rooms can’t be used as security for other real estate (mortgage, caveats etc) otherwise a SMSF can’t be a unit holder
– However should there be a mortgage against the rooms owned in the property trust initially, a SMSF could be later added as a unitholder once the mortgage is discharged
- The transfer of units in the property trust must be transferred at market value, so this may require future external valuations of the rooms plus income tax and stamp duty considerations
- The property trust needs to be in place prior to executing a purchase contract for the rooms
- There are establishment costs for the property trust as well as financial statements, tax returns and any ASIC fees
Option 3 – SMSF acquires the property via a LRBA
Shortfalls in financing may be funded by using a Limited Recourse Borrowing Arrangement or LRBA. These are complex borrowing structures which allow SMSF trustees to take out a loan from a third party lender. The SMSF trustee then uses these funds to purchase a property to be held on trust. The lender only has recourse to the property held in the trust – this is why the loan is “limited recourse”.
Important points to consider:
- There needs to be a registered mortgage over the property
- Where a LRBA is used to acquire property, it must be in place before entering into the contract of purchase
- Once the loan is repaid and mortgage discharged, legal ownership reverts to the SMSF
- Establishment and legal costs for the LRBA are relatively high
- The ATO and bank lending requirements are strict:
– Typically, lenders require the SMSF to have minimum net assets of $200,000 or more, to have a loan to value ratio below 70%
– Maximum term of the loan is 15 years with principal and interest repayments paid monthly
– Many lenders are exiting the SMSF sector due to tightening credit regime and increased ATO regulations
- You cannot use borrowed money to improve the asset or change the nature of the rooms at any time
- You need to be sure that the SMSF will be able to maintain loan repayments in the long term considering asset returns, interest rates, liquidity, and limited contributions caps
Using a SMSF can be a great way to purchase medical rooms and achieve long term capital growth and favourable tax outcomes. However, there are many factors to consider when determining the most suitable structure for your personal circumstances so it pays to obtain professional wealth, tax and legal advice before undertaking any purchase.
Feel free to speak with a DPM Private Wealth Consultant who can assist to determine whether a SMSF is an appropriate vehicle for your medical consulting rooms purchase.
* The information contained in this site is general and is not intended to serve as advice. DPM Financial Services Group recommends you obtain advice concerning specific matters before making a decision.