Commercial Property in an SMSF: Tax Benefits, Borrowing and Key Risks

A practical Case Study

Many business owners focus on growing their business and putting profits back into operations, only to discover later that their superannuation has been left behind.

That was the situation Fred found himself in at age 45. After years of building a successful bike parts business, his income had grown significantly, but his retirement savings had not kept pace.

Fred’s challenge wasn’t finding a property. It was working out whether he could use the success of his business to improve both his business position and his retirement position at the same time.

As the business expanded, he secured several larger supply contracts and his income increased significantly.

Over the previous few years Fred had been earning around $100,000 per annum. More recently, his income had increased to approximately $250,000 per annum and the business was continuing to grow.

The growth was great news, but it created a new challenge. He needed more space.

A commercial warehouse in Brisbane South had become available for around $700,000 and would provide the storage and operational space his growing business required. He had researched the market and felt confident in the growth and rental prospects of the warehouse he was interested in.

Fred had accumulated approximately:

• $100,000 in superannuation
• $400,000 in personal cash savings

Like many business owners, he wanted to know whether there was a way to use his growing business profits to improve both his business position and his long-term retirement outcomes.

Looking at the bigger picture

At first glance, purchasing the warehouse personally seemed like the obvious solution.

However, once we reviewed Fred’s overall position, another option emerged.

Could the warehouse be purchased inside an SMSF?

This prompted a broader discussion around:

• Carry-forward concessional contributions
• Non-concessional contributions
• Commercial property within super
• SMSF borrowing arrangements
• Cashflow management for both the business and SMSF

The super opportunity

One of the first opportunities we identified was Fred’s unused concessional contribution capacity.

As a sole trader, Fred had only contributed around $5,000 per year to super over the previous five years. This meant he had accumulated approximately $117,500 of unused concessional contribution cap space, plus access to the current year’s concessional cap of $32,500. In total, Fred potentially had access to approximately $150,000 of concessional contribution capacity.

Fred decided to utilise the full amount available and contribute approximately $150,000 as a concessional contribution in the current financial year.

Assuming Fred’s income remained around $250,000, the approximate benefits were:

• Estimated personal tax deduction benefit: $60,850
• Contributions tax inside super at 30%: $45,000*
• Net tax benefit: approximately $15,850

This represented a significant amount of money that could remain invested for retirement rather than being paid as personal tax.

*Note: As Fred’s income is $250,000, the concessional contributions are added to his income for Division 293 tax purposes, therefore additional Division 293 tax may apply, increasing the effective tax rate on concessional contributions from 15% to 30%.

Funding the SMSF deposit

We then considered how the warehouse purchase could potentially be structured. Fred had $400,000 in cash.

One possibility was contributing:

• $300,000 as a non-concessional contribution
• $150,000 concessional contribution in year one

This would provide approximately:

• Existing super balance: $100,000
• Non-concessional contribution: $300,000
• Initial concessional contribution: $150,000

Total SMSF balance: Approximately $550,000

Rather than using the entire balance towards the warehouse purchase, Fred elected to use approximately $350,000 towards the acquisition, representing a 50% deposit. The balance of the warehouse purchase price was then funded through a Limited Recourse Borrowing Arrangement (LRBA), allowing the SMSF to acquire the commercial property.

This left approximately $200,000 within the SMSF.

Maintaining these funds was an important part of the overall strategy. The remaining balance provided:

• A cash buffer for unexpected events
• Funds to assist with loan repayments and property expenses if required
• Ongoing diversification through investments outside the commercial property

This helped ensure Fred’s retirement savings were not entirely dependent on a single asset and provided greater flexibility if business or economic conditions changed.

How does an SMSF borrow?

Unlike normal property lending, SMSFs cannot generally borrow directly in the same way an individual would.

Instead, a specific borrowing arrangement known as a Limited Recourse Borrowing Arrangement is used.

Under an LRBA:

• The property is held in a separate holding trust
• The SMSF receives the benefits of ownership
• The lender’s rights are generally limited to the underlying property

This structure allows an SMSF to acquire a commercial property while borrowing part of the purchase price.

Why commercial property can be attractive

One of the unique features of commercial property is that the business can lease the premises from the SMSF.

In Fred’s case:

• The SMSF owns the warehouse
• Fred’s business becomes the tenant
• Fred’s business pays market rent to the SMSF

Provided the arrangement is maintained at market rates and complies with the rules, this allows business cashflow to progressively move wealth into the superannuation environment.

 The benefits

Potential advantages included:

• Owning the business premises
• Building retirement savings
• Significant tax savings through concessional contributions
• Rental income flowing into super
• Potential capital growth within the super environment
• Asset separation between the trading business and the property

Rather than paying rent to an unrelated landlord, Fred’s business was paying market rent to his SMSF. Combined with future concessional contributions and investment earnings, this created multiple cashflow sources that could be used to assist in reducing the LRBA debt over time, as well as building his super balance in other investments.

The challenges

Like all strategies, there are drawbacks.

There are costs and complexity associated with:

• Establishing the SMSF
• Establishing the borrowing structure
• Compliance and ongoing management of the SMSF
• Accounting
• Auditing

Most importantly, concentration risk becomes a key consideration.

If the majority of the SMSF is invested into a single commercial property, diversification may be reduced.

The importance of a cash buffer

One of the biggest mistakes I see is people focusing only on getting the loan approved and the property purchased.

It is important to have a strategy for when things don’t go perfectly.

For Fred we looked carefully at:

• Business cashflow
• Rental affordability for the business
• Vacancy risk (not likely to be an issue where Fred is the longer term tenant)
• Interest rate changes
• Available cash reserves

It was important that sufficient cash remained available inside the SMSF to manage unexpected events.

Thinking beyond the property

The warehouse also shouldn’t become the SMSF’s only investment.

Future concessional contributions, investment earnings and additional savings can potentially be directed into other investments over time.

This helps:

• Improve diversification
• Reduce reliance on one asset
• Build a broader retirement portfolio
• Create liquidity, especially in retirement years when capital is likely to be drawn from the SMSF to fund retirement lifestyle needs.

The warehouse may become an important component of the strategy, but ideally it shouldn’t become the entire strategy.

The warehouse still needs to stand on its own merits as an investment.

A strong tax outcome can enhance a good investment, but it rarely turns a poor investment into a good one.

Investment considerations include:

• Location
• Tenant quality
• Lease terms
• Future demand
• Potential capital growth
• Longer term rental yield
• Rental vacancy rates

Who Might Consider This Strategy?

This type of strategy may be worth exploring for business owners who:

• Require commercial premises for their business
• Have strong and consistent cashflow
• Have significant super and personal savings available
• Are comfortable with the additional costs and responsibilities of an SMSF
• Have a long-term investment horizon

 Why Advice Was Important

While the warehouse purchase appeared straightforward, the real value came from coordinating multiple financial strategies simultaneously.

Fred’s situation required consideration of:

• The timing and tax effectiveness of concessional contributions
• The use of non-concessional contributions
• SMSF establishment and trustee structure
• Borrowing capacity within the SMSF
• Appropriate cash reserves
• Rent affordability for the business
• Asset concentration risk
• Retirement funding objectives
• Current and future diversification opportunities
• Estate planning considerations

Looking at any one of these areas in isolation could have produced a very different outcome. The strategy only became apparent when Fred’s entire financial position was considered together.

Final thoughts

For Fred, the warehouse represented much more than a property purchase.

It became an opportunity to improve:

• His business operations
• His superannuation position
• His tax outcomes
• His long-term retirement prospects

However, the strategy only worked because the numbers stacked up.

Importantly, the decision was not whether Fred could buy the warehouse through an SMSF. The real question was whether doing so would improve his overall financial position compared with the alternatives available to him.

Cashflow analysis, contribution strategies, borrowing capacity, rent affordability and retirement planning all had to be considered together.

For business owners experiencing strong growth, commercial property inside an SMSF can be worth exploring, but whether it is suitable depends on how it fits within your broader retirement, tax, cashflow and wealth creation strategy. The property purchase should support Fred’s broader financial and retirement objectives, not become the strategy itself.

Considering purchasing commercial property through an SMSF? Before proceeding, it’s important to assess contribution opportunities, borrowing capacity, cashflow requirements, diversification and long-term retirement objectives. Professional advice can help determine whether the strategy is appropriate for your circumstances.

SMSF Commercial Property Strategy: Fred’s Case Study Summary

👨 FRED	🏦 SMSF FUNDING	🏭 WAREHOUSE	💰 SMSF ANNUAL CASHFLOW
Age 45	Existing Super $100,000	Purchase Price $700,000	Rent @ 4% = $28,000 p.a.
Business Income $250,000	NCC $300,000	Deposit $350,000	CCs from Year 2 = $32,500 p.a.
Cash Savings $400,000	CC $150,000	LRBA $350,000	Total Annual Inflows = $60,500 p.a.
	Total Assets $550,000	Buffer Retained $200,000	LRBA Interest @ 8% = $28,000 p.a.
			Estimated surplus Before Property Costs and tax = ~$32,500 p.a.

 

General Advice Warning: The information in this article and the links has been prepared for general information purposes only and does not take into account your personal objectives, financial situation or needs. It is not intended to provide commercial, financial, investment, accounting, tax or legal advice. You should, before you make any decision regarding any information, strategies, or products mentioned in this article, consult a professional financial advisor to consider whether it is suitable and appropriate for you and your personal needs and circumstances. Before making a decision to acquire a financial product, you should obtain and read the Product Disclosure Statement (PDS) relating to that product, together with the Target Market Determination (TMD).

Note: This case study is based on a hypothetical client scenario. Figures have been simplified and rounded for illustrative purposes only.